5 Secrets To Trading Options Just Like A Professional Trader

Jay Soloff

Options Portfolio Manager

Editor – Options Profit Engine, 30 Day Dividends

Presentation Copy

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About Me

• 20 years of experience trading options

• 8 years of online research & options services

• CBOE floor trader and market maker – provided liquidity on the largest options exchange in the world for stocks like Amazon

• Hedge fund analyst, options portfolio

• MBA, MSIM, Arizona State University

• BA Economics, University of Illinois

Lessons From February 5th

Feb 5th:

From intraday high to low, there was roughly a 1,500 point drop in the Dow (largest point drop ever but only 6% at its worst point… 1987 crash was almost 23% drop)

Lessons From February 5th

Also on Feb 5th:

Short volatility ETPs got decimated (over 80% in SVXY!), especially in relation to stocks in general. Why? Who got the worst of it?

Options Trading Online Resources

• Marketchameleon.com (analytics, screener)

• Cmlviz.com (backtesting)

• Cboe.com (videos, education)

• Optionseducation.org (education)

• Finviz.com (screener, charts)

• Stockcharts.com (charts)

Options Trading Secret #1

• TRADE YOUR EDGE • There are many different ways to successfully trade options

• Options strategies can vary in success based on your personality and trading style • I’m a volatility trader (usually a seller) that likes self-hedged trades (like iron condors)

• I get into trouble when I start to lean towards heavily directional trades

• If you find something that works for you, it can’t be the “wrong” strategy

• That doesn’t mean you should ignore basic risk management and trade management best practices

Options Trading Secret #2

• Use covered calls as often as possible • In most years, you are better off with covered calls versus only long stocks

(plenty of data to support this, not to mention – just look at block trades)

• Covered calls are very easy and take very little time to implement

• Perfect complement to dividend collection

• A covered call is when you write a call versus every 100 shares of a stock you own to help amplify the yield • Example: An actual Apple (AAPL) covered call trade on May 7th

• Purchased 100,000 shares of AAPL at $186

• Sold 1,000 May 18th 192.5 calls for $0.84 (collecting $84,000)

Covered Calls

• Payoff scenarios • Scenario 1: Apple is at $186 on May 18th

o Stock gains = $0 o Option gains = $84,000 (10 days) o Return = 0.5% (84,000/18,600,000), monthly = 1.5%, yearly = 18%

• Scenario 2: Apple is at $192.5 or higher on May 18th o Stock gains = $650,000 ($6.5 move x 100,000 shares) o Option gains = $84,000 o Return = 4% (734,000/18,600,000), monthly = 12%, yearly = 144%

• Scenario 3: Apple is at $185.16 on May 18th o Stock loss = $84,000 ($0.86 move x 100,000 shares) o Option gains = $84,000 o Return = 0% o Any lower price would result in a loss

Covered Calls

• Pros • Works in almost any environment

• Easy to do

• Consistent income generation (even more so than dividends)

• Cons • Can cap earnings in a high growth environment (note that you aren’t losing

money)

• Takes a fair amount of capital (not a con if you already own the shares)

Covered Calls Results (5% OTM/45 Delta)

5 years back 30 day holding period Held to expiration

Options Trading Secret #3

• Use long vertical spreads for directional trading • For any short or medium-term directional trade, using vertical spreads is

almost always a good idea

• My rule of thumb is any option that costs more than about $0.75 should be countered with a short option to reduce costs

• For long-term options (LEAPS), using naked options is okay because it’s more like a stock purchase (basically trading dividends for leverage)

• A vertical spread is simply buying and selling a call or put in the same expiration, but using different strikes. Long (debit) verticals are when you are buying the closer to the money options and selling the farther out ones

Vertical Spreads: AAPL Example

• Apple stock at $185.50 on May 8th • Bought 1,000 September 195 calls for $5.52

• Sold 1,000 September 200 calls for $3.93

• Total cost is $1.59 • Breakeven point is $196.59

• Max profit is $5 (gap between strikes) - $1.59 cost = $3.41 • That’s $341,000 or 214% gains

• Max loss is $159,000

• Conversely if you bought the 195 calls for $5.52 • Breakeven is $200.52

• Max loss is $552,000

Vertical Spreads

• Pros • Reduced risk (due to lower premium costs)

• Higher returns (lower costs means bigger percentage gains)

• Cons • Can cap gains

Vertical Spreads – Facebook (FB)

Naked Calls

Call Vertical Spreads

Vertical Spreads – Tesla (TSLA)

Naked Puts

Put Vertical Spreads

Options Trading Secret #4

• Use short vertical spreads for credit trades

• A short vertical spread is when you sell the closer to the money option and buy the farther out one to cap risk – the exact opposite of the long vertical trade. This a credit trade where you collect premium. • However, rather than directional in nature, short verticals can be used to sell

volatility

• Does have some directional bias, but far higher probability than debit verticals

• Eventually, as you get comfortable with selling vertical spreads, you can start using iron condors (which is simply selling a put vertical spread and call vertical spread at the same time) • I mix short iron condors and short vertical spreads in my trading service, with the

occasional long trade

Short Vertical Spread Example

• IWM at $165 on July 5th • Sold 19,250 July 20th 163 puts for $1.42

• Bought 19,250 July 20th 155 puts for $0.31

• Total premium collected $1.11 • Breakeven point is $161.89

• Max profit is premium collected or $1.11 ($2.1 million) • Occurs if IWM is above $163 on July 20th expiration

• Max loss is $8 (gap between spreads) – credit received ($1.11) = $6.89 • Max loss is $13.2 million

• IWM would have to drop 6% in two weeks

• Don’t forget that just sitting still will do the trick (which is basically what happened)

• The long strike is key as it reduces risk and margin requirement

Short (Credit) Vertical Spreads

• Pros • Can be a good way to trade volatility with a slight directional bias

• Works in a sideways/neutral market

• Depending on how far out of the money you go, can be very high probability

• Cons • Requires a margin account (usually a minimum of $2,000)

• Max loss is much greater than max gain (trade off due to high probability)

Short Vertical Spread Results (30 delta)

30 days to expiration Held to expiration 3 years back Remember, some directional bias is needed

Option Trading Secret #5

• Six tips to improve your success rate: • Trade liquid options – bid/ask spreads are narrow

• Look at the tape – big trades (block trades) generally come form savvy sources

• Option Sentiment (calls versus puts) can be a useful directional indicator • Check out Marketchameleon.com

• Timing a direction is always tough but sentiment can help you determine when a change may be coming

• Don’t trade “teenies”

• Selling options for credit is high probability, but understand your risks • Remember, trade your edge!

• Always understand the underlying product you are trading options on

Summary

• Trade your edge • There are many ways to make money trading options, but always try to focus

on what you do best

• Use covered calls whenever possible

• Use vertical spreads for directional trades

• Short vertical spreads are a good way to collect a credit

• Remember the six tips for options trading success

Q&A

To Get a Copy of This Presentation

1. Text the word Jay to 213-516-9803.

2. You’ll get a response with the presentation link.

3. I’ll also send a couple of updates on options trades I’m watching.