Stock markets surged more than 4% last week and have climbed nearly 15% this month. We all know this has been one of the best months for stocks in nearly 40 years. Where do we go now though and how should you position your portfolio? I think volatility will still be very prevalent -especially with the amount of “market moving” date this week so you had better be on your toes!

To put the current price levels in perspective, all 10 S&P 500 sectors are currently overbought (more than 1 standard deviation above their 50-day moving average). Moreover, 8 out of 10 are in extreme territory (more than 2 standard deviations above their 50-day moving average). These readings don’t last long.

Historically speaking, the average return for the month following a gain of more than 10% is just 1.44% or a fairly flat market. I’d be hard pressed to see this market actually stay flat.

Make sure to check out our interactive Economic Calendar and get this week’s major announcements on your calendar ahead of time. Be prepared, not surprised. Oh yeah and check out my video analysis below.

Economic Numbers In Focus

In no particular order we had a lot of news these past 2 weeks as it relates to the economy. GDP expanded last quarter at one of the fastest rates in a year. When you dig down into the numbers the gains were in consumer spending and business investment (clearly positive for our consumer driven economy) but a big red flat was the declining income and savings rate.

The FED and Jobs

To add to the slew of earnings and important announcements this week, the Fed is highly expected to announce another round of QE3 (when will it ever end Ben!). Of course this is good and bad right? If no QE program is announced it’s because they believe in a slow but still positive growth rate for the US. On the other hand, another QE program really highlights the fact that they are worried about another recession.

Plus, this Friday the highly anticipated jobs report is due. Most of the analysts on the street expect unemployment to hold steady at 9.1% in October (adding 88,000 jobs). This is still well below a level that is needed to reduce the unemployment rate in the next 6 months.

Yesterday Netflix (NLFX) reported earnings and in after-hours trading the stock was down more than 25%. Yes in a matter of minutes, 25% of the market value of this poor company was gone! Today the stock closed down by nearly 35%. So what’s the point of all this Kirk? Well, I wanted to use NFLX as my “lab rat” and once again show you why I never sell options on individual companies.

I have always preferred to stick with the indexes when option selling for years now. And today really drives home the point I try to make to coaching students and readers all the time. Selling options on individual companies is bad news – and you will eventually get killed.

Here are the top 5 reasons why I don’t sell options on individual companies and stocks:

1) Earnings Gaps

Case in point today with NFLX and thousands of other instances I can point to where the stock makes a huge gap after earnings. GOOG and AAPL are also great examples of this and are highly trades yet gap all the time around earnings. All I can say is that you had better be on the right side of the gap.

2) Bankruptcy

Companies can declare or fall into bankruptcy in a matter of days. Do we even need to mention Lehman Brothers and possibly Bank of America these days? Indexes cannot declare bankruptcy nor can they ever go to zero – ever! Sure there are risks but nothing like selling options on individual companies.

3) Product/Market Shift

In our technology driven market, products and markets can virtually disappear for a company overnight. Take the iPhone for instance. When it was introduced it immediately shifted the way the landscape of the mobile and cell phone market. Cloud computing is another example that is currently stealing markets from companies and service providers. NFLX may also actually be caught up in a market where too many competitors are coming in and replicating their strategy.

4) Merger/Acquisitions

As a former analyst for Deutsche Bank I know firsthand that companies are always looking for ways to buy market share, and at high premiums. These deals are kept secret and can sometimes send the stock gapping higher by 20-40% instantly. Likewise, the acquiring company can see their stock gap lower (people don’t often think of this scenario).

5) Rumors

Social media can spread rumors about a company or stock in seconds – seconds! Good, bad or indifferent, a stock can become the focus of the entire market before you have time to react. Buyout rumors, contract orders, drug approval rumors, etc all can cause extreme volatility.

I Forgot To Mention Liquidity!

Lack of liquidity is one last reason why I stay away from single stock options. Unless it’s a big company name like GOOG, AAPL, MSFT, etc they tend to have very low levels of option volume. Moreover, what small option volume there is cause the spreads between the bid/ask to be so wide it’s not even worth attempting an order.

Stick to the indexes for their liquidity and overall safety when selling options. They are not perfect – no market is. But they offer much better probabilities of making money and won’t give you big overnight surprises like NFLX investors saw today.

During expiration weeks I get a lot of questions about options exercising and assignment. Mostly traders are concerned that their short option contracts or spreads will be assigned at expiration. In an effort to help calm the nerves during the crazy period, I decided to put together this guide to help you understand your risks during expiration week.

First, Be Mindful of Your Strike Price

Exercising and assignment is nearly all about where your strike price is in relation to the current stock price at expiration…

When the stock price is above the strike price, a call is considered in the money (ITM). The situation is reversed when the strike price exceeds stock price — a call is then considered out of the money (OTM). An at-the-money option (ATM) is one whose strike price equals (or nearly equals) the stock price.

OTM Options = Low Probability of Exercise/Assignment

Although an option holder has the right to exercise his or her options position prior to expiration regardless of whether the options are IN or OUT of the money; the reality is that if you are holding a short option an your strikes are OTM then you stand a very small chance of being assigned.

If you are holding short ITM option positions at expiration I would start planning an exit strategy quickly. Buying back the position is usually your best option to avoid assignment or exercising. And please for the love of Buffett, don’t wait until the last day!

Be Cool, Most Options Are Closed Before Expiration

According to OCC statistics for year 2010, the breakdown of option expiration and exercising is as follows:

Closing Sells – 71.6% 
Exercised – 7.9% 
Unexercised at Expiration – 20.5%

Pretty great numbers for short option sellers right? Of all the options that went to expiration, only 7.9% of the positions were exercised or assigned, leaving the vast majority either closed out ahead of time or worthless.

Thoughts On Exercising and Assignment?

Hopefully this helped clear the air – is there anything I didn’t cover that you have questions about? While it is rare to have been assigned, if you have either been assigned or exercised your own option positions I’d like to hear how the process went via the comments below.

October was light but profitable. Again we tried to stay conservative not knowing if the markets would again fall off a cliff (which they didn’t but I’d rather be safe than sorry). Of the trades we did enter they were very profitable, but the amount of excess cash in the portfolio didn’t help. Regardless, small but profitable monthly trading time and time again will build wealth. I’ll take it!

Credit Spread Strategy: 0.96%

To re-cap this month’s income, let’s look at what we made in premium vs. our required investments (in margin). Here are the positions we had with corresponding PROFIT/INVESTMENT and RETURN:

RUT 500/490 PUT SPREAD – $30/$970 = 3.09% Return

With regard to TOTAL INCOME and RETURN, the portfolio produced $30 of income after investing just $970 in margin. That means we saw a total portfolio return of 0.96% this month based on our model allocation.

Naked Puts/Calls Strategy: 1.40%

To re-cap this month’s income, let’s look at what we made in premium vs. our required investments (in margin). Here are the positions we had with corresponding PROFIT/INVESTMENT and RETURN:

SPY 90 PUT – $40/$902 = 4.43% Return

IWM 50 PUT – $20/$500 = 4.00% Return

With regard to TOTAL INCOME and RETURN, the portfolio produced $60 of income after investing just $1,402 in margin. That means we saw a total portfolio return of 1.40% this month based on our model portfolio allocation.

Iron Condors Strategy: 0.00%

Again this month we did not enter any positions for the Iron Condor strategy – and thankfully so with the volatility. All funds remained in cash.

Sick and tired of the recent market volatility and watching your portfolio value swing? Today I decided to cover 8 places to park your cash during these volatile markets. If you are not invested already you are probably wondering where to put all that hard earned cash for a while until things calm down. Just remember that the best short-term investments have to meet YOUR needs.

Cash Parking Considerations

Just like any other investment you make, where you decide to stash some money shouldn’t be blindly decided. Make sure that you consider the following:

1. How often will you need access to the money?
2. What kind of interest are you earning on your money (or do you need to make)?
3. Are there any “other” benefits to choosing a particular institution? Rewards, gifts, etc.
4. What are the penalties for taking out your money ahead of schedule?

Hopefully I highlighted at least one thing that make you second-guess where you are currently parking cash. If so, this post has already served it’s purpose! But if you are looking for more suggestions check out the following list.

1. Money Market Account

For the liquidity and return, money market accounts really can’t be beat. Most give you easy access through checks, transfers, and even ATMs debit cards. This market is typically very competitive but what I have is a Money Market account with my broker TDAmeritrade so I can quickly transfer money back and forth – pennies add up people!

2. High Yield Checking Account

Checking accounts should really be used for monthly transactions, short-term investing. But, some banks these days are offering a combined checking and money market option that does pay a nice little interest rate. The higher your average balance the more you will make in this area.

3. Money Market Deposit Fund

These funds invest in highly liquid and still very safe. The difference between a money market “fund” is that the fund will invest in securities such as certificates of deposit, government bonds, and commercial investment paper. The interest rates and returns on money market funds are typically higher than the average money market accounts. Keep in mind they aren’t FDIC insured.

4. ”I” Bonds (inflation-protected)

The inflation protected US bonds are indexed savings vehicles. The bond’s payment is adjusted semiannually to keep up with inflation and protect the purchasing power of your money. Denominations range from $50-$10,000 so they are even great for some smaller accounts, but you have to hold them for at least 12 months to avoid the penalty.

5. Certificates of Deposit (CDs)

We all have heard about these before. Some banks offer no-penalty withdrawal while other banks lure you in with higher interest rates in you promise to keep the money tied up longer. Depending on how long the CD’s maturity is, it may pay more than money markets but you sacrifice liquidity in the process. I’ve never been sold on these.

6. US Treasury Bills (NOT Notes!)

“Treasuries” as you commonly hear in the news and media are debt instruments backed by the full faith and credit of the U.S. government. T-BILLS mature in less than a year; T-NOTES mature between 2 and 10 years. If you are parking cash sort term stick to the T-Bills. Another perk is that they are exempt from state and local taxes!

7. High Yield Savings Account

These high yield savings are very similar to the checking accounts from above. However, savings accounts typically have restrictions on how many transactions and transfers you can have per month before they hit you will additional fees. The small pennies you earn in savings accounts isn’t enough to even keep up with inflation and could earn more money elsewhere. I don’t even have a savings account anymore.

8. Under the Mattress (the LAST resort)

As a very last resort you can always just keep the money in the mattress. It sure is liquid but I actually think you’ll earn a negative interest rate given the effects of inflation on our US dollar. But hey, whatever helps you sleep better at night right?

I’ve been very busy lately working on a new project for this website. After months of feedback and suggestions I think I am putting together something that will truly help options traders (or any trader really) advance to the next level in their education.

What I’ve found that most traders need can but summed up in 2 main categories:

1) More Video Tutorials! - articles are great and always available for reference, but in-depth and clear video tutorials are the best way to learn.

2) One Platform! - most of the information on trading is scattered at best, and my mission is to bring together as much as I can into one single platform with easy navigation.

Here’s A Sneak Peak Inside Our New Project

I need your feedback! Take just 5 mins to watch this video and add your comments to this post below with your feedback and suggestions on what you would like to see.

Like I mentioned in the video, this new education platform will truly be unique to the options trading world. The more feedback I get from you all now the better it will become when I finish rolling it out next month.

What Kinds of Video Tutorials Would You Like To See?

Don’t be shy – add your comments and suggestions below and let me know what you would like to see. Anything you think is not covered on trading, I’ll cover it! Any tools, patterns, or indicators you would like to see just let me know below. Hell, even if you just like what you see let me know (it doesn’t necessarily have to be feedback).

Yesterday the S&P 500 traded above the 50-day moving average for the first time since July. Technically it is a good signal for the bulls but not the type of billboard buy signal that some people are making it out to be. I would use caution here if you are thinking of long positions in the market now – you missed your opportunity last week.

I have to admit it’s an impressive rally staged by the bulls – one that we all didn’t think would be this strong. Just in the last 5 trading sessions, the S&P has surged nearly 8% and the Russell 2000 has climbed more than 13%. But before you get too hyper keep in mind that we are still firmly in a downtrend at this point and bear market type rallies are strong by nature. I would expect this current rally to get sold fairly quickly if it starts to stall.

At the flip of a switch it seems that investors are no longer worried about the Euro-Zone debt problems. This is far from over and will once again rear it’s ugly head in the near future. Don’t get fooled, stop watching the news and feeding off the top stories. Start exiting long positions and use this opportunity to buy protection for another drop a cheap prices.

With the recent volatility a lot of traders are asking about quick ways to hedge their current credit spread option strategies. As with all hedge positions or adjustments you make, you have to consider the price or premium it costs versus the insurance you are getting. It’s just like buying insurance on your house; you want the lowest premium with the highest coverage.

Protecting Against Vega Spikes

Specifically I’m going to discuss hedging a put credit spread since that seems to be where most traders lose their shirts trading – i.e. when markets are falling hard and they aren’t protected. As stocks fall, volatility typically increases, both increasing margin requirements and also swelling your credit spread premium.

It’s this volatility or Vega that we really want to hedge against. With a credit spread you are betting that the position will expire worthless and thus you are effectively taking a short position in volatility. Decreasing vega will be profitable while increasing vega will be harmful to your position.

Starting With The Base Chart

Here is a profit/loss (P/L) chart that shows what a typically put credit spread looks like at expiration. For this example, lets assume you sold 1 $45 strike put and bought 1 $40 strike put for a net credit of $200.

Notice that if the stock trades any lower than than $43 (your break-even point) you will start to lose the $200 premium you took in on the initial trade. After $42 you are out the entire premium. Clearly you have limited downside risk but you still could be over-exposed to a big market sell-off right?

Leg Into A Put Back-Spread

A quick and relatively easy way to hedge this position would be to purchase another OTM put option at/or lower than the $40 strike price. This will now create a position similar to the one below.

This is a “hedge” and not intended to eliminate the potential for losses but it will protect from further increases in volatility and reduce your overall margin requirements. Now, a huge downside move in the stock will be hedged below $40 and you would actually start to make money if the stock really continues to fall apart.

You still keep a heathly premium on the overall position (assuming the hedge wasn’t too expensive) and protect from a major market move lower. What more could you ask for in an option hedge right.

What Do You Look For In A Hedge?

If you are planning on buying protection or hedging an options position, what are the things you look for? In other words, what are your criteria before making the trade? Add your comments below and share your insight.

Chart patterns are great tools for traders. Their visual and predictive nature make them a favorite for stock traders especially. But, using chart patterns to set stop loss levels are an often overlooked benefit, and yet they are one of the easiest ways to manage risk.

Don’t Focus Just On The Entry

We all spend hours, days and weeks scanning charts and searching for the best setups. All the hard work to enter a trade and yet little consideration is put into managing the risk side? Maybe it’s because we have a nature tendency to think about the money we will make instead of the money we might lose.

Even before you enter a new trade you should have a firm stop loss level in mind. Stops should be placed at levels which indicate that the original trade idea was wrong. And since you know what your risk is ahead of time, having a stop loss level will help control your emotions when and if the trade goes bad.

Use Chart Pattern Failures

Chart patterns can help us manage risk and still allow us to do this in a rationale way.  Since chart patterns have clear and straight forward breakout points then must also have clear failure points as well. The opposite side of the formation offers us our stop loss level.

For example, take this bullish symmetrical triangle which “should” breakout to the top. Once the breakout occurs and you make a long trade, place the stop loss order underneath the pattern should it turn against you.

An Emotion-Free, Rationale Way To Trade

The beautiful thing about using chart patterns with stop loss levels is that it still protects your upside profit potential in the trade. If the breakout continue to push the stock higher after your entry you keep the money. If not, and the stock reverses and falls back down, then your stop loss order will execute and minimize any losses.

Now you are trading emotion free and more like a professional!