Web’s Weekly RoundupFebruary 28, 2015

Twitter: @MarketWebs

Presenter: Web Begole

Day trading, short term trading, options trading, and futures trading are extremely risky undertakings. They generally are not appropriate for someone with limited capital, little or no trading experience, and/ or a low tolerance for risk. Never execute a trade unless you can afford to and are prepared to lose your entire investment. All trading operations involve serious risks, and you can lose your entire investment. No trades are recommendations or advice and we cannot be sued for losses of capital. All trades are for educational purposes only. Contact your broker or RAI for execution, margin, and other capital requirements. Everyone watching presentation adheres to ALL disclaimers on www.optionhacker.com and www.keeneonthemarket.com

RISK DISCLAIMER

Web’s Trading Style

• I like a largely diversified portfolio with uncorrelated underlyings.• At any given moment I have exposure to 20-50 underlyings.• Options positions only. No stock.• Most positions are swing positions – positions lasting longer than a week.• Some positions are earnings plays.• Some positions are day trades using weekly options or futures contracts.• How do I manage this “large book”?

– Each position has limited risk – in general I can only lose ~$500 per position– On a typical day I have 3-5 winners to manage.– In general, I do not manage losers.– I focus on managing the winning positions and doing what I can to amplify the gains.

• Why do I like such a “large book”?– By having exposure to so many different things, the overall market movement has less effect on my daily performance.– With so many positions, I do not have time to worry about any single position.– By limiting my risk per position to a relatively small amount there is more to gain than to lose.– I can focus on the winners and look for new positions as they are taken off for profits.

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Establishing and Managing Limited Risk Reversals

• Using limited risk reversal, I want to get long XYZ• As a swing trade, I want time on my side.

• We’ll discuss:• The establishment of the trade• Managing the trade when it goes

the right way• Managing the trade when it goes

the wrong way

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Establishing and Managing Limited Risk Reversals

• Establishment:• For what ever my reason, I want to get long XYZ and have long exposure for the next month or more.• I don’t want:

– to spend the capital on getting long shares of stock. – to lose money if the stock doesn’t move or only barely moves.– to expose myself to theta or volatility decay burning away my investment.– to have undefined risk in the position with no opportunity to manage it without adding risk.

• My long strategy of choice is the Limited Risk Reversal• Why?

– I define my risk when I put the position on. – I have unlimited rewards in my direction.– I lose little to nothing if the stock does not move.– I have the ability to manage a winning position and better my risk-to-reward ratio without adding additional risk (ie: at no

cost)• Through management of a winner I can increase my profits and/or reduce my risk

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Establishing and Managing Limited Risk Reversals

• Establishment:• For what ever my reason, I want to get long XYZ and have long exposure for the next month or more.• Criteria:

– $500 max risk• Spread or Spreads must not risk any more than $500. Either 1x 5pt wide spread or 2x 2.5pt wide spreads or 5x 1pt

wide spreads– Want the most upside reward as possible

• Call purchased must be close to the money, or multiple calls outside the money– Want reward as fast as possible

• Multiple calls will amplify faster than just one.– This position can not cost me any more than $0.05/1lot to place.

• I am not looking for near term options, I am looking at either the front month option chain or the back month option chain – and always the monthlies, not the weeklies.– Why so far out? I want time to be in my favor, give the stock time to run in my direction.– Why only monthlies? Preference and ubiquity.

• Problem with this:The further out in time one goes, the greater the premium in the options.

• Pros: – Time for the stock to move in my direction towards my target– More premium to be had for the credit put spread

• Cons:– Inflated premium means the calls I want to buy are further out of the money, sometimes impossibly far out of the money

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Establishing and Managing Limited Risk Reversals

• Establishment:• KO Limited Risk Reversal (based on a real life example)• We saw paper coming in and buying lots of May 44 Calls in KO

>> KO 20931 10:02:32 OPENING May15 44.0 Calls $0.33 ASKSIDE IV=14.8% +0.9 AMEX 89 x $0.29 - $0.34 x 586 AMEX Vol=25k, Delta=20%, To Buy, KO=41.65 (-0.08), OI=10k 2/19 Thu>> KO 13914 09:53:43 May15 44.0 Calls $0.50 ASKSIDE IV=17.8% +1.8 CBOE 195 x $0.46 - $0.5 x 250 ARCA Vol=21k, Delta=26%, To Buy, KO=41.87 (+0.02), OI=47k 2/24 Tue>> KO 11046 15:02:02 May15 44.0 Calls $0.55 BIDSIDE IV=18.4% +0.6 BATS 32 x $0.55 - $0.56 x 105 ISE Vol=23k, Delta=27%, To Sell, KO=41.89 (-0.24), OI=70k 2/25 Wed

– First on 2/19: 20,931 for $0.33– Then on 2/24: 13,914 for $0.50– Then on 2/25: 11,046 for $0.55– Total of 45,981 for an average price of (6907.23+6957+6075.3)/45981 = $0.4336 (total investment of $1,993,736.16)

• Notice the dollar amounts for each order on each day, that’s how we can assume it’s the same entity buying the options.

• While I want to get in on that exposure, I don’t want to risk theta decay killing my options, as KO is known to grind higher, not spike.

• Perfect opportunity for a limited risk reversal.• If I go out to May, there’s a lot of premium, and I may not be able to buy the 44s in size.• I don’t wait for the 2/25 order, I’m looking to enter this trade on Tuesday the 24 th.

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Establishing and Managing Limited Risk Reversals

• Establishment:

8

Paper is buying May 44 Calls

Currently marking $0.585

I want a LRR, what are my options?

42/43 Put Spread is Marking:1.94-1.385 = $0.555credit

Selling that put spread only gets me 144 call and cost me money on top…$0.585 - $0.555 = $0.03debit/1lot

Can do this 5 times, get 5 calls total with $515 risk…. Meh….

Can I do better?

Lets move forward in time….

Establishing and Managing Limited Risk Reversals

• Establishment:

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In April the 44 Calls are marking $0.28Half price, not bad!

But what if May is the key? I still want protection.

The 42/43 Put Spread in April is worth:1.635-1.030 = $0.605

That lets me buy 2x the 44 calls.For $0.05credit… (marking 0.28)

OR it lets me buy 4x the 45 calls….For $0.02debit… (marking 0.155)

With 52 days remaining, the volatility increase on an up-move in KO could allow the 4x calls to increase in total value faster than the 2x calls.

Done. I decide to buy 5 lots of this spread:Selling the 42/43 Put SpreadBuying 4x the 45 Calls$0.02 debit / 1lot.5x = $0.10 debit ($10USD)Max Risk: $510.Max Reward: Unlimited.

Result position:Long 5x KO Apr 42 PutsShort 5x KO Apr 43 PutsLong 20x KO Apr 45 Calls

Establishing and Managing Limited Risk Reversals

• Position Dynamics:

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With this position:Long 5x KO Apr 42 PutsShort 5x KO Apr 43 PutsLong 20x KO Apr 45 CallsTotal Debit $10One may say I own 20 of the Apr 45 Calls for $0.005 each.

Long Apr 42 Puts -- $42

Short Apr 43 Puts -- $43

Long Apr 45 Calls -- $45

$42

$43

$44

$45

$46

$47

$41

$40

Unlimited Profits Zone +$!!!

Minimal Loss Zone -$10.00-??

Scratch Zone -$10.00

Full Loss Zone -$515.00

If I simply bought 20x Apr 45 Calls:Cost: (0.155x20) = $310USD.Max Loss $310.00, Max Reward Unlimited.KO must trade at 45.15 by Apr expiration to break even.What if it doesn’t? What if paper is buying the calls just for a pop, not to get them in the money? What if I miss the exit because I expect more?

Establishing and Managing Limited Risk Reversals

• Management of a winner:

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At the end of the day Tuesday 2/24, KO is trading at $42.13 and I have on this position:Long 5x KO Apr 42 Puts @ $1.03Short 5x KO Apr 43 Puts @ $1.635Long 20x KO Apr 45 Calls @ $0.155Max Risk: $510.Max Reward: Unlimited.P&L: $0.00

At the end of the day Friday 2/26, KO is trading at $43.30 and my position looks like this:Long 5x KO Apr 42 Puts @ $1.03 now $0.585 (-$222.50)Short 5x KO Apr 43 Puts @ $1.635 now $0.96 (+$337.50)Long 20x KO Apr 45 Calls @ $0.155 now $0.345 (+$380)Max Risk: $510.Max Reward: Unlimited.P&L: +$495.00

This position is going my way, and there’s still 49 daysremaining…..

How can I manage this position and massage morefrom it?

Establishing and Managing Limited Risk Reversals

• Management of a winner:

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• I think KO still can move higher• I want to amplify Risk-To-Reward

I can do this in two ways:1) Reduce Risk2) Amplify Reward

For both of these purposes, rolling that credit put spread is the method.

I can roll the put spread in two ways:

1) I can roll it up from the 42/43 to the 43/44Buying back the Apr 42/43 costs $0.375Selling the Apr 43/44 receives $0.575$0.20/1lot credit.

2) I can roll it forward in time and up…Buying back the Apr 42/43 costs $0.375Selling the Mar 43/44 receives $0.64$0.265/1lot credit.I choose this option….

Now what?

Establishing and Managing Limited Risk Reversals

• Management of a winner:

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Buying back the Apr 42/43 costs $0.375Selling the Mar 43/44 receives $0.64$0.265/1lot credit.I choose this option….

I receive $0.265/1lot I do this 5 timesI receive $1.325credit (+$132.50USD)

I have two options again1) I can pocket this money and reduce my riskMax Risk = $510 - $132.50 = $377.502) I can use this money to purchase more callsThe Apr 45’s are marking $0.345$1.325 / $0.345 = 3.84…. So I can buy 3 more calls…Does 3 more calls (on top of 20) help me?

Yes… but given that’s all I can get, I opt personally to reduce my risk instead.

Also, I’m increasing time decay in the put spread by bringingit forward. If KO expires above 44 mid March, I am out of my risk!So I take option 1.

Result Position:Long 5x KO Mar 43 Puts @ $0.96Short 5x KO Mar 44 Puts @ $1.535Long 20x KO Apr 45 Calls @ $0.155

As a result of the roll:P&L: +$495.00+$132.50 = $627.50Max Risk: $377.50 Max Reward: Unlimited.

Establishing and Managing Limited Risk Reversals

• New Position Dynamics:

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With this position (post roll):Long 5x KO Mar 43 PutsShort 5x KO Mar 44 PutsLong 20x KO Apr 45 Calls

I received $132.50 credit for the roll.That pays for the $10.00 I spent to establish the position.Remaining credit on position, if calls and put spread go to zero:$122.50

One may say I now own 20 Apr 45 calls for $0.06credit each!

Long Mar 43 Puts -- $43

Short Mar 44 Puts -- $44

Long Apr 45 Calls -- $45

$42

$43

$44

$45

$46

$47

$41

$40

Unlimited Profits Zone +$!!!

Minimal Loss Zone -$??

Scratch Zone +$122.50

Full Loss Zone -$377.50

Establishing and Managing Limited Risk Reversals

• “Management” of a loser:

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At the end of the day Monday 3/2, KO is trading at $39.87 and I have on this position (hypothetical numbers):Long 5x KO Apr 42 Puts @ $1.03 now $4.00 (+$1,485USD)Short 5x KO Apr 43 Puts @ $1.635 now $5.00 (-$1,682.50USD)Long 20x KO Apr 45 Calls @ $0.155 now $0.025 (-$260USD)Max Risk: $510.Max Reward: Unlimited.P&L: -$456.50USD

What are my options?

I can buy back the put spread and remove my risk:Cost: $1.00/1lot x 5 = $500.00USDThe position cost me $10USD to put onResulting position:Long 20x KO Apr 45 Calls @ (5.10/20) = $0.255 each[Originally on 2/24 they were marking $0.155 each]

I could have simply bought the calls originally for $310.00But now I have bought them for $510.00

This is not a good position to be in…

I still have 46 days remaining….

What are some other options?

A) I can short stock around the position…This requires a calculation of the current delta exposureto know how many shares to short…

B) Sell Calls against the 20 long calls.If I sell the Apr 44 Calls for $0.10 each (20 times)I receive $200.00 reducing max risk to $310.00

This turns the position into an iron condor.(No further reduction in buying power)

If I can buy back the short calls later for 0.05 or less I will. (Bringing max risk back to $410.00 or less)

C) Do nothing.If KO expires above 43 on Apr expiration, the put spread is worthless and I keep the credit. I’ll simply ignore what it’s doing now.(Web’s choice)

Establishing and Managing Limited Risk Reversals

• Recap:• Winning LRRS give me many

options towards increasing R/R– Rolling the credit spread is key.

What I do with that money is up tomy discretion

• Losing LRRS have few managementoptions, so I limit my risk on entry.

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Q & A With Web

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