sanglucci.com options training course guide€¦ · table of contents sanglucci methods: combining...

Sanglucci.com Options Training: Course Guide

Disclaimer and Student Responsibili4es Webinars start promptly at 8pm EST. You must come to class prepared with questions having reviewed the material in this textbook ahead of time. Traders are expected to study when classes are not in session and come ready to learn. During class hours questions will only be fielded via comments. Q&A portions of class will allow audio participation. Recordings will be made available for missed classes. Sanglucci.com its affiliates and representatives (collectively Sanglucci.com) have the right to remove any student from a class or any other services provided by Sanglucci.com for no refund if he or she acts disruptively, disrespectfully, or in any way impedes class progress.

Sanglucci.com is not responsible for decisions made by traders who use information from Sanglucci.com writings and/or educational courses.

We do not claim to have a special insight into the markets that prevent us from making mistakes. We do make mistakes. However, we believe our successes more than make up for our mistakes, and will continue to offer our education until proven otherwise.

Trading of stocks, and especially options, involves substantial risk of loss and may not be suitable for everyone. Day trading in the stock market brings with it a high degree of risk; trading options is an even higher-risk undertaking. Traders should carefully consider their decisions and know the risks they take on before placing trades. The valuation of options may fluctuate, and, as a result, traders may lose more than their original investment. You are responsible for all the risks and financial resources you use.

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Table of Contents

Trading Basics…5-23 •  Auction Process •  Candlesticks •  Charts •  Time Frames •  Types of Trades •  Short Selling •  Price Action •  Understanding Sentiment •  Supply/Demand Dynamics •  Technical Analysis and Indicators •  Building a Watchlist •  Sanglucci’s Watchlist

Options…24-39 •  Why Trade Options •  What is an Option? •  What Calls and Puts •  How You Read An Options Chain •  Sanglucci’s Equation for Pricing an Option •  The Underlying Stock •  Time Decay •  Volatility •  Equation For Pricing An Option: Revisited •  Puts vs. Shortselling •  Characteristics of In Money vs. Out of the Money •  Different Classes of Options: Weeklies and Monthlies

Focus •  Profit vs. Loss Potential

Tape Reading…40-55 •  Definition of Tape Reading •  Level II •  Time and Sales •  Bid and Ask as Related to Tape Reading •  Refreshing Orders •  Exchanges and Routes •  Dark Pools •  Tape/Price Manipulation Techniques •  Scanning and Analyzing Large Order Transactions •  Fakeouts •  Timing: Having The Touch and Timing with the

Markets

Continued

Table of Contents

SangLucci Methods: Combining Tape Reading and Options…55-61 •  Before The Tape: Idea Generation •  Selecting the Right Option •  Finding Conviction in The Tape •  Timing Entries •  Exiting Using Trading Platforms…62-68 •  Priorities for Choosing a Platform •  Customizing Layouts •  Adjusting Settings to Maximize Performance: Sang’s

Setup •  Hot Keys •  Multiple Chart Time Frames

Trading Psychology…69-79 •  Market

•  Headline Risk •  Bullish/bearish sentiment •  Anticipation •  Earnings

•  Personal •  Challenging your fears •  Taking losses •  Taking Winners •  When to Size In •  Value of NOT Trading •  Building Your Own Trading Style •  Why Do We Trade?

Trading Basics

Trading Basics: Auc4on Process

Supply and Demand are represented at the Ask (sellers) and Bid (buyers):

•  The price of a stock is set by the last transaction made, regardless of it being a “buy” or a

“sell.” The receipt of this transaction is displayed as a “time and sales” stamp. •  The supply and demand dynamics in a stock market are no different than those of a

physical market or auction of any other kind. •  If there are more bidders trying to buy a product or security, the price will go up. •  If there are more sellers trying to sell a product or security, the price will go down.

Bid, Ask, and Spread Defined:

•  Bid: The price closest to the last transaction that buyers are willing to buy at. •  Ask (aka Offer): The price closest to the last transaction that sellers are willing to sell at. •  Spread: The difference between the Bid and the Ask. This is the amount profited by Market

Makers who are paid to make sure shares of a stock are always available and trading.

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Stock charts are typically made up of units called Candlesticks. •  As each time stamp is recorded by the computer, the price movement of each tick is

compounded into a Candlestick. Candlesticks are vertically-oriented “Box and Whisker” plots.

•  In this case, 50% of trades happen within the box and 50% of the trades happen outside of the box (25% on each “wik” aka the whiskers).

Each Candlestick finishes populating depending on what time frame you have selected.

•  Example: 1 minute, 5 minutes, 1 hour, daily, etc.

Trading Basics: Candles4cks

Image Source: Investopedia.com

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Trading Basics: Charts

Candlesticks populate as time elapses, forming a chart. When Traders analyze charts, we are in reality assessing the movement of the candlesticks forming the chart.

What the chart can tell us:

•  Support and resistance levels.

•  Support: A price “floor” in the stock where buying demand matches selling pressure, halting the movement of the stock’s price below that level.

•  Resistance: A price “ceiling” where selling pressure matches buying demand, halting the movement of the stock’s price above that level.

•  Which of three possible chart environments the stock is currently in: •  Uptrend •  Downtrend •  Consolidation aka “Chop”

•  What stocks to watch and what to set to the side. •  Depending on your strategy, you’ll be looking for different types of movement or

setups within a chart before you further investigate the stock for a trade. A quick look at a chart can often tell you if a stock is worth your time that day.

•  Who are the bag holders, what their mentality is, and where they are in the chart.

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Bagholders Bagholders are the people that are holding the stock at its peak and cannot get rid of their position until the stock has moved lower against them.

Usually bagholders increase the effect of sell/short pressure on a stock; they admit defeat and exit their position, pushing the stock lower with their sells because there is no logical game plan of getting out of their trade other than dumping.

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Chop/Consolidation

Uptrend

Downtrend

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Each of these charts shows the same stock at the same moment from different time frame settings.

The time frames that we use to look at these charts should be proportional to the duration of the trade that we are putting on.

As you can see by these charts, different time frames will completely change our perspective on the stock and consequently what price patterns we recognize.

Trading Basics: Time Frames

5 Minute Chart

30 Minute Chart Daily Chart

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Scalp •  Seconds to minutes. If you are scalp trading you jump in and out of stocks very rapidly,

often picking up gains on penny moves over and over again. Scalp traders typically use specialized platforms with hotkeys to make sure they can enter and exit positions immediately; scalp traders often employ a large amount of leverage. Scalp traders usually use advanced strategies with regard to routing and exchange routing.

•  Scalp trading usually takes place at a prop firm because the technological requirements are so expensive. It is not possible to scalp trade using a retail platform.

Day •  Hours to a full day. Day traders are looking for a larger move in a stock compared to

scalpers. •  Positions usually require multiple entries to reach full size. Stops (predetermined

maximum loss points) are wider because the trade is being placed across a longer period of time and therefore will typically experience more swings.

Swing •  Days. Swing traders hold a position over multiple days. •  Swing trading mostly happens in trending markets (either up or down trending). A swing

trader could slowly piece into a position over multiple days or could put on a position that has a relatively good amount of gains within 1 day and hold it overnight.

Investing •  Two weeks or longer; not relevant for our purposes

Trading Basics: Types of Trades

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Short selling is the process of selling stock that you don’t own in the hopes that you will be able to buy it back for cheaper in the immediate future. In order to sell short, you have to borrow shares of the stock (typically from your broker).

•  Example: Apple is at $620.00. I believe its going down to $580.00. I can short Apple by borrowing shares from my broker at $620.00, selling them immediately in the market, and waiting for the stock to go down before I buy those shares back and give them back to my broker.

•  The difference between what I originally sold the stock for and what I buy it back (minus commissions) is my profit.

Short selling is used when you want to profit from price going down instead of up.

The danger of short selling is that your potential downside is UNLIMITED. •  Example: A trader shorts 10 shares of Apple at $620.00. He has now collected

$6,200.00 (minus commissions). However, Apple makes an unexpected announcement and the stock jumps to $1,000.00. The broker calls and demands that the trader cover his short, so the trader has to buy back his shares at the market price of $1,000.00 per share. He has to pay $10,000 (plus transaction costs) for those shares, which means he loses about $4,000 on the trade, 65% of his initial investment.

•  The unlimited downside potential of shorting is one reason why traders use options.

Trading Basics: Short Selling

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Price Action is the behavior of the Bids and Offers in relation to one another over a period of time, at certain price levels of a stock. As buyers and sellers come in and out of a stock in greater or lesser numbers, they are affecting the Price Action.

Imagine a physical marketplace: If there are only a few buyers and sellers mulling around, placing small orders for goods, there isn’t much activity; the price action could be described as slow. However, if a busload of big buyers and sellers piles into the market and starts buying and selling like crazy, the prices of those goods are going to start moving A LOT. That’s price action.Having a good read on price action is very difficult. That’s the whole point of Tape Reading in the first place.

Specifically, price action refers to the ways that orders go off– whether they are bidded or offered with relatively large amounts of volume. Price action also refers to the behavior of the buyer or seller in relative strength to one another– are buyers overwhelming sellers and pushing the price higher?

•  Example: When there is a stronger buyer involved, the price action--the aggressive buying--will happen on the offer. This suggests that buyers are so intent to buy the stock that they are not willing to wait to have their order filled when they place it on the bid. Instead, they are paying the difference between the bid and the offer and buying shares immediately on the offer. They are paying a premium to buy the stock in the moment.

Having said that, there are manipulative ways to accumulate shares by making the price action look a certain way. Just as you can bluff and cultivate perceptions in a poker game by changing the way you bet, you can bluff and manipulate other players in the market by changing your buying and selling habits.

Price action helps us determine whether a stock is “in play”– whether its worth trading that day. Its usually apparent within the first 30 minutes of the open whether the activity within the stock– the price action– will be such that it will create moves and opportunities to actually make trades.

Trading Basics: Price Ac4on

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Dictionary definition Sentiment: A view or attitude toward a situation or event; an opinion.

Market definition of Sentiment: The prevailing macro view of the market direction. The sentiment is our way of qualifying where the markets will be going in the future.

•  Example: Bearish sentiment prevails in the market after poor macroeconomic reports suggests that the US is heading into a double dip recession.

Sectors and Sentiment: Markets are made of different sectors (tech, financials, casinos, etc.). Each sector has different sentiment as a subset of the overall market sentiment.

•  Example: Google, Amazon, Apple, and other tech sector stocks are falling while Bank of America, Goldman Sachs, JPMorgan Chase and other financial sector stocks are surging upwards. This would imply bearish sentiment in techs and bullish sentiment in financials.

Indexes and Sentiment: You can also look to broad indexes for market sentiment. Bullish sentiment on the S&P 500 (tracked via the SPY) will create bullish sentiment in stocks of almost every other sector.

•  Example: Three weeks of bad data come out but the SPY is still bumping up against resistance levels. The sentiment here is bullish, and we can infer that most investors and traders still believe that markets should be moving higher despite the bad news.

Different stocks have different levels of correlation with the broad market indexes. This is important to factor in as you prepare your Watchlist.

Trading Basics: Understanding Sen4ment

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SUPPLY and DEMAND are the most important factors in trading. A change in Supply and Demand moves a stock. Without that change, the stock DOES NOT move.

Ultimately, traders want to step in front of changes in supply and demand because it is these changes that give us movements in the price of the stock, and therefore the opportunity to make money.

•  Example: When a large fund increases its holdings of a stock, its position size can be so large that it literally removes a large portion of the supply of the stock while increasing the demand. Therefore, when a large fund goes into the market with a large buy order, it will drive the price of the stock up because demand has substantially increased.

•  Example: A Low Float Stock (a stock with little average daily trading volume) •  Lets say the average number of shares traded are 300,000 shares per day. Its very easy to spot a

large trader who wants this stock because his order size and the quantity of the orders are more than the average number of transactions in the stock. Spotting a buyer like this signals a large change in supply and demand and triggers the need for a closer look.

On a large scale, you can see equilibrium or consolidation areas as a price range where supply and demand are in agreement. This is an area where buyers and sellers agree that the price of the stock should be in this area.

•  Breakouts occur when demand (buyers) overpowers supply (sellers), therefore driving the price of the stock upwards.

•  Breakdowns occur when supply (sellers) overpowers demand (buyers), driving the price of the stock downwards.

Trading Basics: Supply/Demand Dynamics

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Breakdown A breakdown is a move out of consolidation into a downtrend. Breakdowns occur when a stock has been trading within a certain range and the price suddenly collapses lower than that range.


Breakdown Support Level

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Breakout A Breakout is a move out of consolidation into an uptrend. Breakouts occur when a stock has been trading within a certain range and the price suddenly escapes out higher than that range.


Breakout Breakout Resistance Level

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Indicator: An analysis tool that traders use to predict the direction of the stock’s price and structure trades.

Technical Analysis: the analyzing of charts: behavior of candlesticks, areas of consolidation, breakdown and breakout areas, and more.

There are hundreds of technical patterns that supposedly indicate high probability trades, and in conjunction with chart analysis there are thousands of different technical studies out there. The point of technical indicators is to display and help the trader understand what is on going with the stock at certain prices.

•  Example: VWAP (Volume Weighted Average Price) is an indicator that can signal that a large number of transactions within a certain time period have taken place at a certain price.

All technical indicators have one shared characteristic: they need historical information to exist.

•  Beginning to intermediate traders will rely on indicators heavily. •  This shared quality also means that traders only using technical analysis will always be

a step behind the market as they wait for their indicators to take shape and calculate.

Trading Basics: Technical Analysis and Indicators

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Technical indicators are helpful for momentum trading because there has to be a jump in volume and/or price for it be considered a momentum trade; oftentimes indicators will pick up on these movements.

-HOWEVER-

Lagging Indicators •  All indicators lag. You will never have the best entries or exits if you are using

only indicators.They might let you catch a move but you’ll probably miss a huge portion of it, especially in a hybrid market where computers using the same indicators can move thousands of times faster than you.

•  Indicators can also overcomplicate your trading analysis, which is the last thing a trader wants.

We’re not here to teach technical analysis; we use key levels based on what the chart tells us and based on what the price action tells us. We aim to get in BEFORE the momentum traders, which means we have to move beyond technical analysis. That’s where Tape Reading comes in.

Trading Basics: Technical Analysis and Indicators

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Before you build a Watchlist, its important to define your style of trading. Some questions to ask yourself: •  Do you trade whatever is hot that day (aka high flyers)? •  Do you trade large range days? •  Do you like to trade within certain ranges of technical indicators? •  Do you like to trade a small basket of stocks that you know well?

Momentum Trades •  If you like to trade momentum plays, you’ll probably be scanning through 100’s

of stocks a night to find the stocks that are building momentum based on technical indicators.

•  This is tedious but plenty of people do it; its quite feasible.

High Flyers •  No Watchlist. You literally wait until the next day to see what’s popping and then

trade that.

Trading Basics: Building A Watchlist

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Trading Basics: SangLucci’s Watchlist:

We made it through a top-down approach: •  We are looking for stocks that have relatively good liquidity (trading volume) on the

options. Liquidity is essential because without liquidity we cannot exit a trade immediately and lock in gains or cap losses.

We know that capital flows through different sectors (Sector Rotations). We’ve built a watchlist with a diverse number of sectors specifically so that we can take advantage of Sector Rotations.

•  We watch broad indexes (SPY) and our stocks to see which sector is leading the indexes in a certain direction.

•  Example: We’ll watch Goldman Sachs (GS). Lets say it reaches new highs in the morning on high volume. We look at the rest of the financials and see they are rising as well. We look at the SPY and compare its behavior to the rest of our stocks. If the rest of the sectors aren’t moving, we know that the financials are moving because they are moving with or before the broad indexes.

•  Therefore we know which sectors are hot and which sectors are lagging. Sectors that are weak during a bull rally will be optimal for short positions if the bull rally stalls and turns into a bear market.

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Trading Basics: SangLucci’s Watchlist

Tech: Amazon (AMZN) Apple (AAPL) Facebook (FB) F5 Networks (FFIV) Netflix (NFLX) Priceline (PCLN) Yoku Inc (YOKU)

Financials: Bank of America (BAC) Goldman Sachs (GS) JPMorgan Chase (JPM)

General/Index 20+ Year Fed Treasuries (TLT) S&P 500 (SPY) Silver (SLV) Gold (GLD)

Casinos Las Vegas Sands Cop (LVS) Wynn Casinos (WYNN)

Industrial: CF Industries Holdings (CF) Potash (POT) United States Steel Corp (X)

Credit Cards American Express (AXP) Mastercard (MA) Visa (V)

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Options

We trade options because they require less money for higher potential returns. Example: You have a $600.00 stock. You buy 100 shares, which costs you $60,000.00. If the stock moves up $5.00 to $605.00, you make $500.00.

That’s a lot of money to put on the line to make $500.00 (1% return on investment).

Instead, you could play an option. Lets say the 605 Call is at $3.00. If you spend $60,000 on this option, you would have 200 contracts. If the underlying moved $5.00, your 200 contracts are now probably worth DOUBLE (100% return) what you paid for them. You would be walking away with $40,000.00-$60,000.00 in profit.

There is of course substantial risk that you take on in order to achieve this type of return, but you can see the sizeable gains that options can provide.

Op4ons: Why Trade Op4ons?

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An option is a contract that permits the buyer (holder) the right to buy or sell an underlying security at a specified price (strike price) for a specific date (expiration date). •  Equate an option to a bet, like on a football game, except you’re not just betting on something happening in the game,

you’re also betting on how long it will take that outcome to occur. If you think the Packers are going to score 28 points against the Patriots, you’re not just taking that bet, you’re betting whether it will happen in the first quarter (not likely) or by the end of the game (more likely).

The option only provides the right to transact on the terms of the contract; it does NOT require or obligate the buyer to exercise the contract. •  If you chose, you could purchase an option and allow it to expire without exercising it. There are plenty of strategies

that take advantage of this capability.

Each contract of an option equates to 100 shares of the underlying stock. •  So when you buy a single $2.00 Call in Bank of America, you are going to pay $200.00 for that 1 call. The listed price

of the option is NOT what you actually pay for it. •  This is why using “leverage” when trading options is rare… an option already requires 100 times more capital than

simply purchasing the common stock.

The Strike Price is the price at which the contract allows the buyer to trade the underlying stock at. •  Think of the strike price as YOUR bet on the game. If you think the Packers will score 28 points, that’s your strike

price. If you think Apple is going to 605, that’s your strike price.

The Expiration Date is the date at which the option expires or is no longer valid. •  This is the ticking clock on your bet; you have to be right BEFORE this date. If not, the value of your bet is ZERO.

Op4ons: What is an Op4on?

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Here are the more technical definitions of the two types of options, Calls and Puts.

A Call option gives the buyer the right to purchase 100 shares of the stock at a certain price before a certain date.

•  Buyers of Call options want the stock price to GO UP. •  Example: A trader purchases one $6.00 Call contract for Bank of America. The expiration date is three

weeks away. The next day, Bank of America trades up to $10.00. Theoretically, the trader could exercise his option, in which case the seller of the option would have to sell him 100 shares of Bank of America stock at $6.00. The trader could then go back out into the market and sell those 100 shares at $10.00, making a $4.00 ($10.00-$6.00) profit per share (minus transaction costs). In reality, options trade just like stocks, so the trader would simply sell his call option for a large profit instead of translating it into stock.

A Put option gives the buyer the right to sell the stock at a certain price before a certain date. •  Buyers of Put options want the stock price to GO DOWN. •  Example: A trader purchases one $600.00 put contract of Apple. The expiration date is 2 weeks away.

Two days later, Apple is trading at $540.00. Theoretically, the trader could exercise his option, in which case the seller of the option would have to buy 100 shares of Apple from him at the strike price of $600.00. Since the trader just sold shares that he didn’t own, he had to borrow them, which means he’s short. To cover his short, he goes back out into the market, buys Apple at the current market price of $540.00, and gives those shares back to the entity that initially let him borrow the shares. The trader makes a profit of $60.00 ($600.00-$540.00) per share (minus transaction costs).

Op4ons: Calls and Puts

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Op4ons: How You Read An Op4ons Chain

This week’s Option

Next week’s Option

Expiration Date

Strike Price

Bid and Ask for Calls Bid and Ask for Puts

Every platform will display an option chain differently, but there are a few common denominators, as highlighted below. Note that this chain was captured on a Thursday, which means that there are two series of weekly options displayed (those expiring this coming Friday and those just released on this Thursday expiring next week). This is only true on Thursday or Friday.

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Op4ons: What is an Op4on: The Equa4on for Pricing an Op4on

This is the way we look at options while trading and what you need to know in order to trade options live:

Price of Option = Underlying Stock + (Time Decay) + Volatility

In the next few pages we define each of these variables and how they relate to the price of an option.

Note that this is clearly not the Black-Scholes Model or any other complicated way of pricing an option. Simplicity (without sacrificing accuracy) is paramount when it comes to trading, which is why we haven’t overcomplicated our formula unnecessarily.

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Op4ons: The Underlying Stock

The underlying stock ultimately has the most influence on the value of an option. As the underlying moves, so will the price of your option.

•  If we were to take away time decay and volatility, an option represents 100 shares of the underlying stock.

•  Direct correlation for Call options: as the value of the underlying stock increases, the value of Calls will generally increase.

•  Inverse correlation for Put options: as the value of the underlying stock decreases, the value of Puts will generally increase.

Options are really about analyzing the price of the underlying, the movement of the underlying, and correlation to the option that you decide to trade with. Some options don’t respond favorably to the movement in the underlying. Choosing the option with the most profitable correlation to the underlying is the key to making a profitable options trade, and that means you need to understand PERCEPTION.

Perception: Where is the underlying going, what’s it doing, how is it getting there? If we think its going down, how fast is it going down? Slow bleeding or big immediate drop?

This is why our strategy is so heavily predicated on Tape Reading; it allows us to understand the movements of the underlying stock. In order for you to effectively trade an option, you need a good understanding of how the underlying stock moves.

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Op4ons: Time Decay

Time Decay exists because options have a finite lifespan.

Recall the analogy of the bet on a football game. The less time you have until your bet expires, the less time your bet has to hit a point where it becomes profitable. Therefore, you would naturally pay more for a bet that had more time left for it to come to fruition.

It’s the same with options.

Holding Volatility and the Underlying constant, an option that expires in 10 days will be worth more than an option that expires in 4 days; the 10 day option has more time to hit its strike price (or stay there if its already there), so its inherently worth more.

So you actually pay a premium for more time being left in the option. Time Decay eats away at that premium. The closer to expiration you get, the faster it will decrease the option’s price, constantly pulling it downward.

As such, if you are going LONG an option that is close to expiration, you need to have serious conviction that movement in the underlying or volatility will overwhelm the strongly negative effects of Time Decay. Otherwise, the price of that option is headed down very quickly.

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Op4ons: Time Decay

If you are a buyer of an option, Time Decay works against you by decreasing the price of the option as it approaches expiration.

If you are a seller of an option, Time Decay works in your favor by decreasing the price of the option and allowing you to profit from your short position.

There are strategies considered “Time Decay Strategies” where the trade is essentially a bet based on shorting an option in anticipation that Time Decay will bring its value down to zero. These strategies make a bet that Time Decay will overwhelm any movement in the underlying and Volatility that would both push the price of the option upwards.

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Op4ons: Vola4lity Volatility is composed of a number of factors, most importantly the trading volume in and price movements of the underlying stock. The quicker, larger, and more violent the price change the greater Volatility will be in the option.

•  Just because there is a high-amount of Volatility being factored into the price of the stock DOES NOT mean that the price of the option or the underlying equity is “volatile.” This is a misnomer.

•  Example: There is often increased buying and selling activity leading into an earnings announcement. However, this increase in volume does not necessarily create dramatic price movement in the underlying. So Volatility in the options is increasing while the underlying stays steady.

When volatility goes up, the price of an option goes up (the reverse is also true). •  If a stock pierces through support or resistance levels with high volume, the option can jump in

price. Lets say in this example that the option goes from $.30 to $1.00 because of the increase in the price of the underlying AND the high Volatility. If the same stock gradually grinds upward toward that resistance level and breaks through with relatively low volume, the same option might only jump from $.30 to $.45.

•  See chart examples on next page.

Put simply, if your stock is acting crazy, the perception increases that your “bet” or strike price might come into play. That means the price of the option is going to go up.

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Op4ons: Vola4lity

This chart is an example of a slow trickle downwards in the price of the underlying. The volatility in this type of move is minimal, therefore the effect on the price of the options will also be relatively small.

This chart is an example of a violent price drop. The volatility in this type of move is extremely high, which means the options would respond with large and immediate price movements.

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Op4ons: Equa4on for Pricing an Op4on: Revisited

Now that we’ve taken a look at each variable in the equation we can see how a movement in each one affects a Call vs. a Put.

Price of Option= Underlying Stock + (Time Decay) + Volatility

Calls Puts

Underlying Stock

As the Underlying Stock increases in value, the Price of a Call goes up.

As the Underlying Stock decreases in value, the Price of a Put goes up.

Time Decay

As Time Decay increases, the Price of the Call goes down.

As Time Decay increases, the Price of the Put goes down.

Volatility

As Volatility increases, the price of a Call goes up.

As Volatility increases, the Price of the Put goes up.

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Its important to understand the difference between shorting and a Put. Both are ways to capitalize on downward price movement in a stock.

However, Puts have limited downside. Shorting does NOT; you could lose an unlimited amount of money by taking on a short position.

Going “long” a Put means that you believe the price of the underlying will decrease. Worst case scenario for buying a put is that the stock moves against you and you let your options expire worthless. All you’ve lost is what you paid for the option to begin with, plus commissions.

Shorting means that you are selling shares of a stock you don’t own, which means that you have to borrow them. Eventually, you have to give those shares back to whoever let you borrow those shares (your broker). If the stock goes down, you can buy the shares back for less than you sold them for and make a profit. If the stock goes up (which it could theoretically do forever) you have to buy those shares back at the market price to give them back to the entity that permitted you to borrow them.

Op4ons: Puts vs. Shortselling

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In the Money (ITM) Out of the Money (OTM)

An option is said to be “In the Money” (ITM) if it can currently be exercised for a profit. Calls are ITM when the strike price is lower than the current price of the underlying stock. Puts are ITM when the option’s strike price is higher than the current price of the stock.

An option is Out of the Money (OTM) when it cannot be exercised for a profit. Calls are OTM when the strike price is higher than the current price of the underlying stock. Puts are OTM when the option’s strike price is lower than the current price of the stock.

ITM options are more expensive because they have already achieved their strike price. This gives relatively less room for Time Decay to affect the option.

OTM options are cheaper and therefore capable of providing much higher percentage returns as the likelihood of moving into the money increases.

Volatility and Time Decay have less of an effect on ITM options. While trading ITM options, put more emphasis on the movement of the underlying.

Volatility and Time Decay are huge factors on OTM options. Pay just as much attention to them as the underlying.

Bid and Ask spreads are easier to manage; liquidity is less likely to dry up.

Bid and Ask spreads are much more difficult to manage. Liquidity can become an issue, especially if you are trading with size.

Potential gains and losses are smaller. Potential gains and losses are larger.

Op4ons: Characteris4cs of In the Money vs. Out of the Money

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Op4ons: Different Classes of Op4ons

Option contracts come in multiple time frames. There are weeklies, monthlies, yearlies, LEAPS… we’re focusing on weeklies and monthlies.

Monthly options expire on the third Friday of each month at the day’s trading close of 4pm. •  Example: An October Call of Bank of America expires on the third Friday in October (the

19th). The last chance to trade it is before the close on that Friday.

Weekly options open up for trading at the open on Thursday and expire at market close on the following Friday, which means they only have a lifespan of seven days. They do not have weekly options for the week where the monthly options expire. •  Continuing the above example, weekly options issued on October the 4th expire on Friday

the 12th. However, there are no weekly options issued on October 11th because those options would expire on the third week of the month– the same week when the monthly options expire.

Because they expire more quickly, weekly options are more volatile and more difficult to trade.

Always know the expiration date of your option before you trade it!

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One advantage of options is that your upside is unlimited while your downside is limited (on the LONG side) but you can still use them to capitalize on all types of price movement.

Theoretically, you could buy a far out of the money option at $.05 and a huge move in the underlying could send it to $1.00. You'd make 20 times your money.

The big thing to understand about options is that you can only lose what you put on the line when you are going LONG. Meaning if you put $20,000.00 down for an option, you can only lose $20,000.00.

•  The main advantage is a capped loss when you want to take advantage of the downside of a stock (puts). Without options, the only way to take advantage of the downward movement in the stock would be to short the stock, which leaves you open to unlimited losses.

Options also allow you to make trades and take positions that would otherwise not be possible. •  If you are a swing trader and you think the stock is going down 5 points over the next 5

days, your broker will not allow you to hold a short position for 5 days because you are too exposed to too much risk for too long. Therefore, its better to buy a put option and have that be your max exposure.

Op4ons: Profit vs. Loss Poten4al

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Tape Reading

Tape Reading: Defini4on of Tape Reading

Tape Reading is a method of trading that seeks to identify the causes of short-term movement in a security’s price. Tape Readers analyze a number of data indicators on a moment-to-moment basis, including transaction receipts and trading volume, to identify activities of buyers and sellers affecting the supply and demand within a security.

By analyzing the activity of these entities, the experienced Tape Reader can formulate price predictions and subsequently employ advantageous trading strategies.

In other words, Tape Reading is watching what is happening on the Level II and the Time and Sales (collectively “The Tape”) to interpret the buyers and sellers of a security in real time.

Its watching the buyers and sellers, as they are buying and selling, to determine which direction they are pushing the stock.

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Tape Reading: Level II

The Level II is the visual representation of the bids and offers for a security. Bids are on the left side, offers are on the right side. The orders shown are the ones closest to the currently trading market price, with the top order for both bid and ask displaying the best price to buy or sell the stock, respectively.

To understand the concept of the Level II, picture 1 million people sitting in front of their computers plugging in orders of where they would like to buy and sell a particular stock. Then someone compiles that list and organizes it. That is the Level II.

Be aware that most Level II’s for stocks take off two zeroes when displaying the size of any bid or offer, which means that 1=100, a 10=1000.

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Tape Reading: Time and Sales

The Time and Sales is the receipt of transactions for a security. These are trades that have actually been executed.

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Tape Reading: Bid and Ask as Related to Tape Reading

In the tape, we're looking at how the Bid and Ask dynamically move together; we're looking at frequency of the change in both Bid and Ask; we’re looking at size of the orders on Bid and Ask; we’re looking at transactions and where they are going off—on the Bid or on the Ask, or in-between?

•  Every transaction has a buyer and a seller. When they meet on a price, that’s when a transaction can be made. That transaction goes off on the offer, on the bid, or somewhere in-between.

•  When a trader aggressively wants to buy, he will skip beyond the bid price and “hit the offer,” meaning he will pay the cost of the spread in order to get filled immediately. When sellers “hit the bid” they are going past the offer with their selling price to sell at the bid and get out immediately.

Example: The normal behavior of a support area, if we see it on the tape, means that at that price there are a lot of bidders lining up. Any sellers “hitting the bid” do not scare away or move the bidders away from the price that they are bidding the stock at. This communicates that despite selling activity (increased supply), the buyers (demand) are keeping the stock level at a certain price level. In turn, this will create a support area.

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Tape Reading: Bid and Ask as Related to Tape Reading: Refreshing Orders

The actual size of a trade can be hidden on the Bid and Ask as well, especially on the equity. These are called Refreshing Orders.

•  One giant bidder could be bidding at $5.00. On the Level II, the size of his order could show 500 shares. In actuality, the size of his order could actually be 500,000 shares. Its completely legal for him to do this. In this case, after the bid gets hit several times it still stands there—refreshing– and doesn't go away.

•  This is why its so important to watch the time and sales to watch for manipulation. You can hide your size on the Level II; you CANNOT hide your size on the time and sales.

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Tape Reading: Exchanges and Routes

Exchanges are the end destination of your trades. Routes are the paths that your trades take to enter the exchange.

•  There are many different exchanges. •  Examples: NYSE, NASDAQ BATS, Arca, CBOE

•  And there are even more routes: •  Examples (options only): Knight (NITE), Lamp (LAMP), C2, Box, ISE, EdgX. •  Each one has a different cost associated with it. Some offer rebates.

Many platforms geared toward active traders have capabilities of routing through different exchanges.

•  If you are using a retail trading platform your trades may be automatically routing to where exchange fees are high or there is no liquidity (no fill= no trade, or you can’t get the shares to short).

Each exchange charges certain fees for adding and removing liquidity. •  Adding liquidity means that you are posting your order on the Level II. •  Removing liquidity means hitting the market button and removing an order out of the Level

II. •  Most of the time, exchanges want to see more orders on the Level II because it facilitates

more trading of the stock. As such, exchanges are more likely to reward adding liquidity.

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Tape Reading: Exchanges and Routes (con4nued)

Exchanges are different from routes. •  Although they pop up in the same place in the Level II •  Companies—Market Makers, BD’s—create smart routes or algo routes.

•  These companies leverage their volume that clears through the different exchanges to incentivize traders to use smart routes, which most of the time are cheaper than trading directly into the exchange.

•  They sniff out liquidity so they can get you better fills, they can execute faster—in essence, they give you better access to the markets.

Example: You see trades on the Level II, the bid is at $8.00 and the offer is at $8.01. You see that the Bid and the Offer are about to flip, meaning the bid is going to be $8.01 and the offer to $8.02. There are routes that can get you filled on this flip at $8.003, so that you get a better execution than if you were to hit the offer at $8.01.

This is essentially what certain high frequency algorithms do—search for arbitrage opportunities within execution routes and exchanges, making pennies at a time over millions of shares.

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Tape Reading: Exchanges and Routes (con4nued)

The takeaway from this is that if you are trading something that has a lot of momentum and players the routes that you choose to get an early fill on your entry are very important. A bad route won’t get you filled as the price breaks aggressively upwards.

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Tape Reading: Dark Pools

Dark pools are a way for institutions and professional traders to execute large trades and to hide their intentions for the direction they want to push the stock.

•  Dark pool trades exist “inside” the bid and the ask.

Typically, to show that you want to sell or buy aggressively you have to “hit the bid” or “hit the offer.”

In dark pools, a trader can mask a trade by transacting within the bid and ask spread. This means that the trader pays a different price for the stock and the order DOES NOT SHOW UP ON THE LEVEL II.

•  Dark pool orders DO show up on the time and sales. However, you do not know if the transaction is in favor of buying or selling.

•  Often times Dark Pool transactions will come up on the time and sales with more than the usual 2 decimal points because they are trading within the spread.

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Tape Reading: Tape/Price Manipula4on Techniques

The most basic forms of Tape/Price Manipulation Techniques are:

Large bids stepping up higher. •  A large bid of unusual size •  Example: A 20,000 share bid is put at $30.02. Ten seconds later it has

moved up to $30.10. This continues to happen until someone sells the 20,000 to this bidder. The outcome of this is forcing the stock higher by giving the perception that they are an aggressive buyer.

Larger offers stepping down •  The reverse is also true. •  Example: A 30,000 share offer is put at $31.15. Ten seconds later they

drop their offer to $30.90. This continues to happen until someone buys the 30,000 offer. The outcome of this behavior is that the price of the stock will go down because its perceived that a large seller is aggressively exiting or shorting the stock.

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Tape Reading: Tape/Price Manipula4on Techniques (con4nued)

Other Forms of Manipulation:

Pre-market gaps: •  During the afterhours and pre-market sessions, liquidity for any high-volume stock is extremely

low. Therefore, its easy to push a stock up and down a significant amount before the market opens.

•  This is used as a way to build a certain perception of trading activity for that day—to create the illusion of a trend. •  Example: They push Apple up 5 points in the pre-market but the real move during the day will

be a sell-off.

Large Market Sweeps •  Often used at a stock’s turning point. •  At the end of a trend, you’ll see a large sweep up or down which signals the end of that move. •  The sweeps get more people to buy in or short the stock, and that’s when the move ends.

Manipulation against technical levels •  Chart patterns and technical analysis is now used so much that it can be used against you, and

it often times is. •  Example: Lets say you have an ascending triangle with a breakout level of $30.00. Often times

they will break that level and come right back below that level, producing what we call a “fakeout.”

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Tape Reading: Scanning and Analyzing Large Order Transac4ons

Its important to see when “size”—large orders– are being shown and to learn to anticipate the reaction of the equity on size shown.

The reaction of the stock, when a large order is shown, is more important than the order itself. •  Large orders can be placed by institutions, hedge funds, or large traders and they can be

pulled immediately. So they could easily be a fake order.

When analyzing the reaction, you want to focus in on the transactions in the time and sales after the order gets put out.

•  Example: Large offer is put at $29.74. Ask yourself, after looking at the tape, is the stock now weak because of that order? Are people selling on the bid because that order is there? Or, is the stock holding right at $29.74 and/or people are still buying at the offer, unfazed by this large sell order?

•  The order itself isn’t important; what is important is how the rest of the participants trading the stock react to that order. That reaction will give you a read on the current sentiment for the stock and may provide you with a trade.

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Tape Reading: Fakeouts

As described before, a Fakeout usually happens at a place where the most eyes are on a certain technical level.

•  The idea behind a Fakeout is that if a large trader or institution can establish an accepted perception, it has the ability to lead the herd into a slaughter.

•  Below, you see Mastercard bumping up against a resistance level. The Fakeout occurs when the price briefly breaks through the resistance level before immediately plunging lower. Its quite possible for a large trader to momentarily push the price across that level.

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Tape Reading: Timing: Having the Touch and Timing With the Markets

When day trading options for a short term move in an underlying stock, timing is one of the most important factors of you becoming a successful trader.

•  Trades have to be timed with the broad indexes, so being able to understand the sentiment on the major indices is as important as picking the right stock to trade.

Timing is about sifting through the noise on the tape and positioning yourself for a particular trade at the right moment.

•  Example: You're buying a breakout but the tape is showing no aggressive buyers and no volume. Therefore, its probably not the right time for you to go heavy into the trade, even though you want to put on a long position.

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Sang Lucci Methods: Combining Tape Reading and Options

Sang Lucci Methods: Combining Tape Reading and Op4ons

This section of the curriculum is structured for live note taking and learning through interactive examples. Treat this section as a workbook

and take notes as we go along.

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BEFORE THE TAPE: IDEA GENERATION


•  Assessing underlying sentiment using charts and simple technical analysis (broad indexes, treasures, precious metals).

•  Market sector sentiment analysis •  Thesis Formation– what do you

think is going to happen?

________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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•  Choosing the expiration and strike price.

•  Understanding ebb and flow of that

particular option. •  Calculate profit potential– is this

trade worth your time?

FINDING AN OPTION ______________________________

__________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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CONVICTION IN THE TAPE

•  Proving or disproving the investment thesis

________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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TIMING

•  Catching Fakeouts •  Entering and re-entering •  Returning to the tape

________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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•  Day trade vs. swing trade vs. scalp trade approach.

•  Adapting to what the market gives

you

EXITING ______________________________

__________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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Using Trading Platforms

Using Trading PlaXorms: Execu4on

Many retail platforms force you to click at least 4 times before you can execute a trade. THESE ARE BAD for our purposes.

Good execution platforms are ones that allow you to set up hotkeys and click a single button to get into a trade. THESE ARE GOOD for our purposes. •  The difference can be 5-10 seconds, which can easily mean 1000’s of dollars when

trading options.

Latency •  Latency is the time between you placing the trade and it actually being filled by your

broker. •  Platforms have different latencies for execution. •  Many retails platforms are visually appealing but are high latency, meaning if you

throw a market order it may go through 3 different brokers. They are not made for traders trying to rapidly enter and exit stocks; they are made for investors.

•  Example: ThinkOrSwim—(High Latency, poor execution). The actual ticks in the time and sales may be as much as 1 second off from a low latency platform. This may be okay for swing traders and investors, but it is not okay for active traders.

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Using Trading PlaXorms: Visuals Due to technological limitations, there is an inverse correlation between low-latency and high-quality visuals. Typically, when you have a fancy platform, your execution is going to suck. The reverse is also true. This is why many traders use multiple platforms, i.e. using ThinkOrSwim charts while using a low-latency platform to execute. There is nothing wrong with using charts from a platform with great visuals (Fidelity, ThinkOrSwim) and using a different platform with execution capabilities better suited to scalping or day trading to actually put on your trades.

Retail Platforms (generally high-quality visuals, more technical indicators, slower

data feeds, non-customizable routes)

Direct Market Access Platforms (DMA-fast execution, low latency data feeds,

customizable routes, better fills, better speed of tape)

Think or Swim LiveVol

Schwab Sterling

Fidelity DAS Trader

TD Ameritrade Fusion

Brokers through retail bank programs like JPMorgan, Bank of America, etc.

Tachyon

Laser

Lightspeed

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Using Trading PlaXorms: Customizing Layouts

Depending on what you value more, you could have more charts for technical indicators and a very small execution section for your Level II, or if you don’t rely on charts very much you could have a number of time and sales displays and Level II’s.

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Using Trading PlaXorms: Adjus4ng SeZngs to Maximize Performance: Sang’s Setup

The setup has to be something you are comfortable with. When you have a conviction for a trade, it needs to be one easy fell swoop.

See live screen sharing of Sang’s setup

We value execution. Its crucial that we have low latency and immediate fills in order to effectively use our strategy. If we had to wait 5 seconds longer to place our trades, the difference would be ENORMOUS in terms of performance.

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Using Trading PlaXorms: Hot Keys

Hot keys are mostly used by proprietary traders to reduce the number of keystrokes and clicks required in order to place a trade. They allow you to press a single key to execute orders that would typically take multiple keystrokes and mouse clicks. For scalpers, hot keys are essential.

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Using Trading PlaXorms: Mul4ple Chart Time Frames

5 Minute Chart

30 Minute Chart Daily Chart

These charts show Goldman Sachs. They are snapshots of the same moment across different time frames. Set up your monitors so that you can see as many different perspectives of the market as necessary to perform the analysis you make.

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Trading Psychology

Trading Psychology: Market: Headline Risk

A trader has to exercise constant awareness of the major economic headlines that move the markets.

•  Watching the economic reports themselves is not as important as monitoring the perception of those numbers and the reactions in the markets.

•  Example: GDP numbers came in better than expected; however, the market had already priced in that number, and as a result the indexes sold off. This is an example of “buying on the rumor, selling on the news.”

Paying attention to every bit of economic data or news report is not advantageous to any trading strategy.

•  Bullish/bearish sentiment •  A trader needs to “feel,” not just see, the underlying sentiment in the market

and indexes. •  Example: In a bull market, most negative economic reports are thrown aside

and any dips in the market are bought up very quickly. This is a trend that you need to follow, and through continuous practice you will begin to see these patterns and literally feel connected to the sentiment in the market.

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Trading Psychology: Market: An4cipa4on

When you are trading large caps, the largest moves and the largest opportunities are when you have a broad market move.

•  Unfortunately the “smart money” does their best to mask what direction that move will be in.

•  You need to be able to anticipate by watching reactions to headline risk and by watching the sentiment in different sectors.

•  You have to understand the manipulation. Think to yourself: If someone were trying to manipulate you into a trade, how would they be doing it? Does the trade you’re about to go into look like it is this kind of setup? •  Example: Markets overextend themselves off of a news report, and that

overextension is a form of manipulation.

The LEAST expected move is the one that yields the most profit because no one has priced this move in on the options. That means that those options are extremely cheap.

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Trading Psychology: Market: Earnings

Trading around earnings is typically considered RISKY due to the simple fact that investors could react negatively to a positive earnings report, and vice versa. The reactions to earnings are very difficult to predict.

•  Example: Apple blows out earnings but the stock is down 10% because they didn’t beat analyst expectations as much as some people thought they would.

•  Market sentiment has to be factored into trading around earnings as well. If current sentiment is bearish it will hold back or otherwise obscure the move of an earnings beat.

•  Unless there is a very significant reason to act otherwise, we stay away from trading around earnings.

There are successful ways to trade earnings but they require a lot of research in regards to reactions to earnings in previous quarters.

•  Using complex options strategies like spreads, strangles, and butterflies, you can minimize that added risk when you are playing earnings.

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Trading Psychology: Personal: Challenging Your Fears

Trading is a mental endeavor! 90% of the game is mental. Once you understand how to make money, its all a game with yourself.

The fear that negatively affects a trader’s performance comes from a variety of different sources. •  Fearful of the sacrifice needed to make to make it work.

•  Sacrificing time with family and friends. •  Opportunity costs. •  Fear of taking the plunge into something that’s not guaranteed.

•  Fear of failure. •  Fear of what people will say. •  Fearful of your own success.

•  You have to believe that you have earned the success that comes with a good trade, when that happens. If you don’t believe that you’ve rightfully earned money that you make, it can create disastrous mental consequences when you actually do turn a profit.

One of the greater myths in trading is that you must remove emotion in order to be a good trader. That’s not possible. Instead, you have to learn to be aware of your own emotions and use them as another source of information that steers and informs your decisions. Your emotions are another data feed that you can use to factor into your decision-making process.

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Trading Psychology: Personal: Taking Losses

Losses are a cost of doing business.

Trading markets is not about being right or wrong; its about taking a position with the information that you have in front of you and accepting the outcome of that position no matter how it goes.

You have to put in the work so that you have conviction in your decisions and confidence in yourself. If the position turns against you and you lose money, you have to know that your original thesis had strength to it, and although it didn’t turn out in your favor, your mental process was not necessarily wrong.

Starting out small is a GOOD thing because it allows you to steadily and safely increase your pain threshold. Do not be too quick to increase the size of your trading account just because you want to stroke your ego. •  Taking a $1,000 loss now might seem world-wrecking, but in 3 years it will be

happening daily and you won’t think twice about it, assuming a larger account size.

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Trading Psychology: Personal: Managing Winners

Win or lose, a trade is just a trade.

A win often motivates you to take bigger risks, get cocky, or do things you wouldn't normally do. Always remember that the next trade has nothing to do with the outcome of the previous one.

•  Trades are not mutually exclusive—they exist independently of one another. Mentally speaking, the next trade has nothing to do with the previous one!

Working toward control of your emotional state after both a win or a loss is essential.

•  If you accept the outcome of your bet before you put the trade on, then the outcome should not affect your mental state.

•  When you put on a trade and tell yourself that you have a specific stop… MAKE SURE YOU STICK TO IT! This discipline separates average traders from good traders, and good traders from great traders.

•  If you’re thinking about the victory before the trade is over, you’re in bad territory.

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Trading Psychology: Personal: Value of NOT Trading

Whatever your trading strategy is, its not going to work all the time and in all market environments. That’s just the nature of the market.

You will eventually be wrong.

You need to be able to recognize when your particular strategy is yielding profits vs. not making any money.

•  That’s when your mind takes over. You start pushing things that aren’t working and taking bigger positions sizes because you are playing your emotions. You think just because you are sitting in a chair in front of your screens you are obligated to trade. Ironically, your identity as a trader tricks you into trading when you shouldn’t.

•  This can lead to another onslaught of debilitating emotions, which will lead to even more mistakes.

Stepping away and not putting capital at risk is often the strongest part of a strategy.

CASH IS A POSITION!

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Trading Psychology: Personal: Building Your Own Trading Style and Iden4ty

There is no one strategy that fits all.

Of the millions of strategies out there, there is no one strategy that fits every person. Part of your evolution as a trader is to identify and practice the strategy that resonates with who you are as a person.

Your personality defines your trading strategy, your goals and what you want out of your trading career.

•  A strategy has to be adapted to develop your unique style. •  Example: You are not comfortable taking overnight positions while someone

else might be more than eager to take a gamble overnight. That could be because he works the night shift and can watch the markets from his toll booth. That might mean that you gravitate toward scalping while the other guy chooses swing trading.

Its important to stake out your identity—that’s why good traders are often headstrong people.

•  A trader cannot successfully use several different trading strategies…its too much for the mind to manage.

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Source: http://traderfeed.blogspot.com/2009/07/what-is-value-of-trading.html

“In mastering risk and uncertainty; in learning to pursue opportunity in effortful ways; in making ourselves better as decision makers; in becoming more disciplined actors; we improve ourselves as human beings. That carries over to many areas of life, so that we can become better business partners, spouses, parents, and friends.

Indeed, this might be the most important distinction between trading well and trading poorly: When we trade well, we make ourselves stronger, better; we tap into the best within us. When we trade poorly, we succumb to our lowest common denominators.

The value of trading is the value of any competitive performance activity: in its mastery, we become just a bit closer to our ideals--and that ripples throughout our lives.”

-Brett Steenbarger, Ph.D

After you’ve traded for long enough, you’ll realize that trading has to be about more than money, and we traders do it for reasons beyond getting rich.

Its about mastering ourselves.

Trading Psychology: Why Do We Trade

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Conclusion

Contact and Resources

[email protected] 212-203-0482 www.Sanglucci.com

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