As the stock market heads into the last trading week of the year, the historical performance figures actually favor the bulls slightly. Last week the market inched out a slightly gain on the YTD return numbers. Odd how all the trading for an entire year comes down to just this last week.

If stocks have a good week, we’ll end the year higher overall. Anything less than a 4% return overall YTD is big loss for investors in my book. With investing expenses, taxes, and inflation a return under 4% to me would be a flat and inefficient use of money. If you aren’t moving forward, you are moving back.

Above are the statistics for the last trading week since 1928. Generally speaking the market has seen gains more than 60% of the time. With the VIX as low as it’s been in recent weeks I’d be wildly surprised to see a sell-off at this point (next year is a whole different story).

Too often I hear new traders talk about how they like to buy options that are cheap because they think it’s a good investment. I can understand where they are coming from because they relate option pricing to how stocks are priced. Cheap stocks are seen as a good investment because they can quickly rise in price – but it’s not the same case with options trading.

Cheap Compared To What?

When someone says they buy cheap options they typically mean that the absolute price is low. They will buy options around $25 each for example and think they are just “stealing money” somehow from the market. But in reality this option below on has a 20% chance of making money at expiration.

You see they are not comparing the pricing to any historical guide or point or reference. Just because an option is priced low doesn’t mean that it’s cheap. And likewise, just because an option is expensive doesn’t mean that it a great investment either.

How To Evaluate Option Pricing

As you start to plan out your next options strategy, there is one main factors you should evaluate before making the trade. Again it’s important to have a frame of reference before you go blindly buying options all over the place that are $25 each and wasting your hard earned money.

Implied vs. Historical Volatility

As option traders we measure how expensive or cheap options are using a parameter called implied volatility, or IV for short. All the data point shows is what the market is pricing in for future volatility of a particular stock.

High IV is synonymous with expensive options and thus shows that there is a lot of fear in the market which is driving up prices due to increased risk. Low IV is synonymous with cheap options and shows either complacency and/or greed in the market.

The implied volatility of the option will indicate the market’s expected trading range for the stock going forward. Since historical volatility can be plotted on the charts you can see how it compares to current implied volatility levels.

Remember, this doesn’t mean that the market will always do what you want it too just because the historical trends are in your favor. It’s all about odds and probabilities. Over time, making the right trade and managing risk will lead to profits.

Spend Your Time Analyzing The Stock

The reality is that the market is going to sniff out any easy profits (always has and always will). There are big banks and large traders who have much more time and money to spend searching for these little pricing inequalities than you or I do.

I suggest you spend your precious time looking at the technical indicators and analyzing the underlying stock.  Timing your trade properly is much easier than digging for a mispricing in the options market.

Today we are opening the new position as follows: Trade: Sell RUT January 830 Call AND Buy RUT January 840 Call Premium: $30 (0.30) Net Credit or better per contract Underlying Price: $730 Max Return: 3.09% Break-Even Price: $830.30 Time Until Expiration: 31 Days Probability of Loss: 2.56% Trade Explanation: For the Credit Spread portfolio we are adding our 1st trade [...]

I often have a hard time trying to explain how short selling stock works and more importantly, why we need it to keep the market alive. Now I understand completely the biggest hurdle that people have to overcome when we talk about short selling stock and it’s the ability to sell something you don’t own yet.

But all too often short sellers get a bad wrap from the main street investing community when in fact short sellers are vital role to keeping the markets moving and efficient.

What Is It & How Does It Work?

Let me put this into very simple terms. You’ve heard the adage “buy low and sell high” right? Short selling is the exact opposite of that. You first sell the stock at a high price and later buy back the shares at a low price. The part that gets people confused is that the trader doesn’t own the shares they sell.

If you don’t own the shares then how can you sell them right? Here’s how you do it. You have to borrower the shares from your broker and immediately sell the shares in the open market. Since you borrowed the shares you now have an obligation to deliver them back to the broker at some time in the future.

Just Like Any Other Obligation

As with anything in life, if you borrower something you have to eventually pay it back. In stock trading, you do this by repurchasing shares in the market and delivering those shares back to the broker. Prior to entering any short sale trade though you must be approved for margin trading with your broker.

The goal of a short seller is to purchase the shares back in the market for a lower price in the future and net a profit. Again think “sell high and buy low” this time. If the opposite happens then you lose money (you sell the shares and have to repurchase them at a higher price down the road).

Don’t Crucify Short Sellers!

In the media, short sellers are getting a lot of attention and are seen as “betting on stocks to fail” when in reality they are simply making educated decisions about investments. Just like a long trader will buy undervalued shares in hopes of a rising price in the future, so too will a short seller look for overvalued companies that might go through a correction.

Short sellers are never directly responsible for these rapid market moves downward. If people keep buying stock then the markets will always continue to move higher – it’s just that simple. In reality, short sellers keep the market efficient by providing higher levels of liquidity at times when other investors are on the sidelines.

The similarities are growing by the day as I compare the historical market top indicators for the 2008 market top and the current volatility. If you’ve been reading this blog for a while you know that I’ve highlighted this comparison numerous times before and I’ll keep pointing it out until it doesn’t work.

Watch this video update as I go over the two charts below in more detail. And don’t forget to add your comments below and let me know what you think about the possibility of 2,000 point sell-off on the Dow Jones?

2008 Market Top

Below is a chart of the 2008 market top and I’ve highlighted areas of support, resistance, and consolidation. It’s really amazing to see the turn in hindsight because it was so clear. I just hope we all don’t fall into the same trap this time around.

2011 Market Top?

I was just talking with a coaching client last night and had reminded him that a market top is simply the same investor psychology cycle with a different catalyst. In 2008 it was the sub-prime mess and right now that could be the Euro debt crisis.

Today we are opening the new position as follows: Trade: Sell SPY January 100 Puts Premium: $25 (0.25) Credit or better per contract Underlying Price: $124.21 Max Return: 2.51% Break-Even Price: $99.75 Time Until Expiration: 38 Days Probability of Loss: 5.53% Trade Explanation: For the Naked portfolio we are entering our 1st trade for the January portfolio. We didn’t exactly see the [...]

Setting and managing price target alerts through your broker’s platform can help you be a far more productive trader. Whether you work a full-time job already or have made the leap over to trading, price target alerts can help you manage the hundreds of charts and trading opportunities each week.

Narrow Your Watch List Instantly

It’s easy to get lost in a sea of stock charts. Believe me, I’m sure over the course of my career thus far I’ve looked at a couple million charts already! So anything that can help me become more productive and focus only on the charts that require my attention is work exploring.

Price target alerts help you narrow that 200+ stock chart watch list you currently have down to a more reasonable and manageable handful. There’s really no use at all to scan over 200+ charts each morning/night if the stock isn’t moving. You’re wasting your time and your money.

Start With Stocks You Want To Trade

Before you set your alerts you first need to narrow that unrealistic watch list. Focus only on the stocks/options you know you want to and can trade. Throw everything else out the door because it’s wasting your time to look at something you won’t trade.

Identify Patterns or Indicators

Now that you have a short list of “tradable stocks” go through them in details and identify the chart patterns, indicators, support/resistance levels that might lead to a trade in the future.

For example, if we are trading the stock above and find a pennant/flag pattern, you could use the chart to set price target alerts. You know that the stock will breakout eventually right? But the timing and direction and unclear right now…

Set Price Target Alerts

Go into your broker’s platform and set specific price target alerts for the stock above so that you are alerted via email when the stock breaks out. In this example, we will set email alerts for both 1,225 and 1,275.

It doesn’t matter how long it takes or if the stock breaks out higher or lower, the system will automatically alert you via email when it’s ready to make a trade.

Sit Back And Wait For The Signals

Once you have alerts set on a couple great stocks, just sit back and wait for the market to tell you when to make a trade.

Honestly it sounds so simple, but doing this can free up so much time for you to do other things (like work a day job) or study a new options trading strategy. The whole idea is that you are removing your emotions and letting the market tell you which way to trade.

You don’t have to search and scan all night long looking for the best opportunities because they literally hit your email inbox each morning.

Even a monkey can buy/sell an option, catch the market at just the right time, and watch the money roll in. But we all know that these trades are only in our sweet trading dreams. The reality is that positions will go against us and you must learn how to adjust option trades and become a flexible trader.

Adjusting an option position really is an essential skill for any investor – I would even say it is a mandatory requirement. Properly managing risk by adjusting can help you repair strategies that have gone wrong, limit huge losses or even create additional potential gains (yes adjusting can add to your bottom line sometimes).

As a disclaimer it’s important that you know both HOW to adjust an option trade and that you are aware of the additional broker commissions you will be charged to exit/enter additional contracts. Take your time when adjusting so that you don’t adjust and create an even bigger hole from which to dig out of.

1. What’s the goal?

Don’t adjust because you are bored. Make sure that you are either A) reducing risk somehow someway or B) creating a new strategy that could make you more money. More often than not you are going to be adjusting to reduce risk so make sure that it does that. Rolling into a position with a lower premium and bigger risk is never a good idea.

2. Are you “really” reducing risk?

Just as I mentioned above ask yourself this question honestly. Forget for a minute that you are not going to make money if you get into a bad trade…focus on NOT losing all the money you have left! I favor reducing risk buy purchasing OTM puts/calls that will hedge against big moves in volatility and Vega.

3. Should you just close out the trade?

This is always one of my 1st considerations. If you’ve made a small profit and things are starting to go south it might be a wise decision to just close out the trade and re-evaluate the market. Don’t let your ego get in the way of making money. Nobody is right on the market direction 100% of the time (not even 51% of the time). The best traders know when they are wrong and get out fast.

4. How have the market technicals changed?

I’m sure when you entered the trade you had a firm opinion on the market. Has that changed now? Have some of the major technical analysis indicators turned the corner unexpectedly? If so, does this change your opinion on the market outlook. More importantly, if the trend is changing then is your options strategy structured to profit from the new market? Wait to see a medium term change to adjust and remember that 1 day doesn’t make a trend.

Vote On The Hardest Strategy To Adjust…

Add your comments below and let me know what you think is the hardest strategy to adjust; credit spreads, naked options, ratio spreads, etc. I’ll follow up this post with a new post on how to adjust the strategy with the most comments.

November trading again was very active with adjustments but profitable here at Option Alpha. For the stock market, if it hadn’t been for the 4% move on the 29th it would have been a very red month. Needless to say, I tried to stay conservative all month and took risk off when necessary which did reduce our overall returns.

Sometimes the best strategy is to trade less not more and I think unsuccessful traders are learning that the hard way. As we near the end of the 2011 trading year we have consistently shown that small but profitable trades time again will build wealth.

The annual returns found here speak for themselves at this point.

Credit Spread Strategy: 1.61%

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 810/815 CALL SPREAD (Closed Early) – $5/$480 = 1.04% Return

SPX 1,050/1,045 PUT SPREAD – $20/$480 = 4.17% Return

With regard to TOTAL INCOME and RETURN, the portfolio produced $25 of income after investing just $960 in margin. That means we saw a total portfolio return of 1.61% this month based on our model allocation.

Naked Puts/Calls Strategy: 0.46%

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:

OIH 85 PUT (Rolled From 90) – $0/$950 = 0.00% Return

SPY 100 PUT – $15/$1,00 = 1.50% Return

SPY 134 CALL (Closed Early) – ($20)/$1,150 = (1.75%) Return

DIA 90 PUT – $20/$900 = 2.22% Return

With regard to TOTAL INCOME and RETURN, the portfolio produced $15 of income after investing just $4,000 in margin. That means we saw a total portfolio return of 0.46% 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 but we happily hang onto the huge profits from earlier in the year.

I’ve written a lot of really good content on technical analysis over the past couple of years, and I figured it was time to put it all the best content into one place, so that anyone who was starting out trading would have a simple beginner’s guide. The goal is that you would be able to learn the basics on the major technical analysis indicators.

So it is after more than 3 hours of pulling it all together. A collection of the finest guides, tutorials, videos, articles; complied together in the order that they should be read.

Click the titles for the full articles. Let me know what you think via the comments!

Why Technical Analysis Is Superior

Technical analysis is the superior way for investors and traders to make decisions when trading stocks and options. For many option traders, technical analysis gives much clearer entry and exit signals for making money in the markets. While it’s true that some investors dismiss technical analysis as inconclusive and arbitrary, the fact remains that technical analysis (when used properly) has a lot of empirical evidence to support it as a reliable trading tool.

Support And Resistance

One of the most difficult concepts for beginning traders and some professionals alike is the understanding of simple support and resistance levels. As such, we decided to provide this very simple explanation of support and resistance levels to help you “get over the hump.”

Moving Averages

Moving averages are very popular among beginning traders and investors. They are simple to use and give very easy indicators to buy/sell a stock. The 200-day moving average is generally the most talked about along with the 50-day moving average. Moving averages do not predict price direction, but rather define the current direction with a lag. Moving averages lag because they are based on past prices – which is mainly why the are not a great short term trading indicator.

Bollinger Bands

Bollinger are one of the most popular technical studies used today. They are simple and give clear signals which is why so many traders use them on a daily basis. However, their relation to volatility and prices moves may reveal some shocking discoveries. Or at the least give you a little more understand of how they REALLY work in today’s fast moving market.

Relative Strength Index (RSI)

RSI is a momentum indicator or oscillator that measures the speed and change of price movements in a security. Traditionally it will move between 0 and 100. It is usually considered that the stock is overbought when RSI is above 70 and oversold when RSI is below 30.

Fibonacci Retracements – Fans, Arcs, Time Series

Fibonacci retracements, fans, arcs, and time series are some of the best technical analysis tools for traders. They are not a perfect indicator (what is right) but they are very helpful if you know the basics.

Ribbon Studies

Ribbon studies and multiple moving averages are becoming more and more popular among trend traders. The basic idea behind the technical indicator is that you are using roughly 12-16 different moving averages on the same exact chart (instead of using just 1 or 2 on your chart).

Moving Average Convergence/Divergence (MACD)

Whipsaw trading can really put a damper on your portfolio, so let’s take a step back right now and do a quick mini-lesson on technical analysis and MACD Divergence. After looking at charts for the past 5 days sitting on mostly all cash heading into expiration, I’ve noticed that the technical are flashing some important warning signs. Mainly I’m seeing a whole bunch of divergence.