Student Chat – A Basic Put Trade

pat [10:17 AM]
Literally any question you have, just ask me. DM, e-mail, whatever.

student
[10:24 AM]
appreciate that. still trying to get my feet wet, and understand what to ask. part of it is understanding the language yall use. so the DIS trades you posted. I read over those, and I still have no idea what I should do to follow yall on that trade.

pat
[10:40 AM]
Live on the Margin covers a lot of the basics. If you haven’t read it, you might give the second half of the book a read…

[10:40]
http://www.omentoring.com/category/beginner/

[10:40]
bunch of stuff there.

student
[10:41 AM]
Thanks!

pat
[10:41 AM]
http://www.investopedia.com/university/options/?ad=dirN&qo=investopediaSiteSearch&qsrc=0&o=40186
Investopedia
Options Basics Tutorial
Discover the world of options, from primary concepts to how options work and why you might use them. (142kB)
Dec 2nd, 2003 at 11:00 AM

[10:41]
The book that Matt posted about the options bible is pretty intense, but great once you have the basics down a bit.

[10:42]
The basic gist of the DIS trade was that I anticipated that it would continue down. To profit from a falling stock using options we buy puts.

[10:43]
This was a 9/20 crossover trade, which isn’t covered much here…

[10:43]
But the basics of that are that the 9EMA (exponential moving average) crosses over the 20SMA (simple moving average)

[10:44]
In my chart, the 9EMA is the thin blue line, the 20SMA is the purple line

[10:44]
Do you have tradingview charts?

[10:45]
If not, you should sign up for a free account.

pat
[10:45 AM]

student
[10:45 AM]
yeah I love that tool

pat
[10:45 AM]
Try and set your charts up to look like mine. It’ll make it a lot easier for you to follow along.

[10:45]
That rising gold line is the 200-Day SMA

[10:46]
The reddish line is the 50-Day SMA

[10:46]
Purple 20-Day SMA

[10:46]
thin blue 9-Day EMA

[10:47]
Also, just yesterday I had another person mention that it’s getting hard to follow along with the conversation in the chat. Along with you, that helps me realize that I’ve started to get too comfortable assuming everyone is getting what I’m talking about.

[10:47]
I’ll work on that.

[10:47]
I was better when OM first started out at explaining everything as we went along.

[10:47]
I’ll try and get back to doing more of that again.

[10:48]
Do you see the 9/20 crossover there?

[10:48]
Ideally, the 20-Day will be flat to slightly in the direction of the crossing 9

[10:48]
This one was perfect.

student
[10:51 AM]
yup, I see it. so definitely get the indicator signaling the downturn. im trying to sort out how to take advantage of it with the puts

[10:52]
assuming it has something to do with this screen here

student
[10:53 AM]

pat
[10:53 AM]
Bingo.

student
[10:54 AM]
thats where i get hung up

[10:54]
no clue what that page is telling me

pat
[10:54 AM]
So the first thing you would do is choose the expiration date you want to use. Generally, I trade the next full month. In this case, July

[10:54]
See the row of purple dates?

[10:54]
July17

student
[10:54 AM]
yup

pat
[10:55 AM]
If it shows just the month and year like Jul17, that means they are the “monthlies”.

[10:55]
These ususally have the highest volume and open interest, which means the best bid/ask spreads.

[10:56]
The others, like Jun-30-17 are the “weeklies”

[10:56]
monthlies always expire on the 3rd Friday of the month.

[10:56]
So, stick with the monthlies, unless I specify a weekly option trade (rare).

[10:57]
So click on July17 and unclick the May17 so you are sure the only option chain you are looking at is the July17

[10:57]
That page, by the way, is called an Option Chain.

[10:57]
Down the middle are the strike prices.

[10:58]
Again, 9 times out of 10 we’ll trade the at-the-money strike. If DIS was at 109 when we put the trade on, that would mean the $110 strike.

[10:58]
If we aren’t at-the-money we’re generally within 1 strike of it either way.

student
[11:00 AM]
ok, so let’s use today for example

[11:00]
price is currently at 106

pat
[11:01 AM]
So if we wanted to be short DIS, thinking the stock was going to continue down, we would likely buy the $105 puts.

student
[11:02 AM]
ok. and so I click on it and it gives me a window to buy/sell

pat
[11:02 AM]

pat
[11:03 AM]
Before you do that, let’s look at the option chain.

pat
[11:03 AM]
So you can see in the screenshot the Bid is 2.28 and the Ask is 2.33

[11:04]
That’s a good tight market. .05 cents wide at this price is only 2%. That’s good. We don’t want to trade options ever that have a spread of 10% or more.

[11:04]
Scan across and you can see there is good volume and open interest.

student
[11:04 AM]
why is that

pat
[11:05 AM]
volume is the number of contracts that have traded today, open interest are the number of contracts open and outstanding.

student
[11:05 AM]
the <10%

pat
[11:06 AM]
Because assume that you get somewhere in the middle of that. Basically you will buy it 5% above the bid, and sell it 5% below the offer. You essentially begin the trade 10% in the hole.

[11:06]
Like you need the trade to move 10% in your direction before you can reasonably break-even.

[11:06]
That’s a big hole to start in.

student
[11:07 AM]
ok

pat
[11:07 AM]
But when it’s tight like this, you are talking about maybe 1% on the buy and 1% on the sell. Doesn’t matter.

[11:08]
Okay, so next look at the delta.

[11:08]
$105 puts delta is .41

[11:08]
That means that for every $1.00 the stock price moves, the option price will move .41 cents.

[11:09]
So, if we assume you bought the puts at $2.30, a $1 move in DIS would represent an 18% move in the option.

[11:09]
Delta is important because it is how we determine our risk in a trade.

[11:11]
Let’s say that DIS is at 106.50 when we make this trade, and that our stop (the place we would bail out) is at 107.20 (maybe there was strong resistance on the chart at 107.10)

[11:11]
That would mean that we are going to close the trade for a loss if the stock goes up .70 cents.

[11:12]
So to determine what our risk on the option is, we multiply .41 by .70 and get .28 cents. then .28/2.30=12%

[11:12]
So our risk is 12%.

[11:13]
We can do the same for the reward side. Let’s say our target for DIS is $105.00. If the stock moves $1.50 our option will move .60 (1.50x.41).

[11:14]
That’d be a 26% winner (.60/2.30)

[11:14]
We might determine that that’s not enough reward for the risk. It’d be close. I usually like to see 3:1 reward to risk ratio.

student
[11:16 AM]
ok, this is making a lot more sense now

pat
[11:16 AM]
It takes a few of these rundowns for it to click. I’ve done a lot of these. :slightly_smiling_face:

student
[11:16 AM]
how is delta actually determined?

pat
[11:17 AM]
Delta is calculated using something called the Black Scholes Model and is completely impossible to understand how. :slightly_smiling_face:

student
[11:17 AM]
ok

pat
[11:17 AM]
Just trust the number they give you.

[11:17]
But…

[11:17]
at the money delta will be .50 (maybe .49-.51)

[11:18]
As an option becomes more in-the-money the delta increases, and as it becomes further out-of-the-money the delta decreases.

student
[11:18 AM]
have you seen anything today thats remotely interesting we could do a paper account walkthrough on?

pat
[11:19 AM]
Sure, bring up GM

student
[11:20 AM]
9/20 on monday

pat
[11:20 AM]
good

pat
[11:20 AM]

pat
[11:21 AM]
so it had that, and it also had decent support at 32.78

[11:21]
I had an alert set on TV to tell me when that support broke. It went off and I almost made the trade, but I don’t know, something else was going on at the time, and within just a few minutes it had crashed.

[11:21]
I was bummed.

[11:22]
Anyway, it’s too far from the stop to really make the trade, but it’s a decent paper trade example here, and there’s still a good chance it could continue lower.

student
[11:23 AM]
31 or 32 strike?

pat
[11:24 AM]

pat
[11:26 AM]
Okay, I’d be looking at the 32 puts. 31 puts I can tell right off the bat are too hot. 31 puts are .48 cents with a delta of .29. That’s 60% on a $1 move in GM.

[11:27]
32 puts are .88 cents and a delta of .44. Still 50% on a $1 move.

[11:27]
granted $1 in GM is a big move.

[11:28]
So, look at the chart again, you can see I had 32.78 as support. Now it’s resistance because the stock blasted through it.

[11:28]
So we would set our stop just above there. Let’s just say 32.80.

[11:28]
This trade would have been a lot better if the stock were at 32.60 or so.

[11:28]
You’d be closer to your stop, but have lots of downside potential.

[11:29]
Anyway, let’s just pretend we’re making this trade.

student
[11:29 AM]
k

pat
[11:29 AM]

pat
[11:30 AM]
You’d click anywhere on the option and this would come up…

[11:30]
We’re buying the puts, because we think the stock is going to go down.

[11:30]
So you’d click buy.

pat
[11:31 AM]

pat
[11:31 AM]
Only two things you need to do here. Choose your quantity….

[11:32]
To do this, you need to determine your trade size.

[11:32]
Let’s say we’re feeling sort of confident in this one, but not overly.

[11:32]
We’re going to go with a 1/2 size.

[11:32]
When I say this, this is what I mean.

student
[11:32 AM]
so what do the size fractions refer to

pat
[11:32 AM]
A full size trade for us at OMentoring is considered 15% of your portfolio.

[11:33]
Since we usually limit our risk to 20% on a trade, that equates to a risk of 3% of your portfolio on the trade. (20% x 15%)

[11:34]
So, when I say 1/2, that means 7.5% of your portfolio value.

[11:34]
$10,000 account would mean $750 on this trade.

[11:34]
So, we’d take $750 and divide by the cost per contract which is $79 (100 x .79)

[11:35]
Basically 10 contracts would be the right size for a 1/2 size trade on a $10,000 account.

[11:35]
make sense?

student
[11:35 AM]
yup

[11:38]
whats next after qty

pat
[11:39 AM]
Then it’s just a matter of price. In this case it’s pretty easy, you either want to buy them right this second, and you’d choose a limit price of .79 (to hit the Ask and get filled immediately).

[11:39]
Or, you’d try and squeeze for a penny and bid .78.

[11:39]
If a market is wider, say .10 cents, you’d generally pick something in the middle. Unless it was moving really fast and you just really wanted to get filled.

student
[11:42 AM]
Ask is at .81 now

[11:42]
so will my .79 just sit there and not get filled

pat
[11:43 AM]
glad this was just a paper trade, or we’d have already missed 2.5% profit.

[11:44]
Yeah, .79 will just sit there until the stock climbs higher, and your order gets hit. But if the stock continues down, you’ll miss it.

[11:44]
So the decision is how bad do you want it here?

[11:44]
For paper trade purposes, you can just buy it at .81 to get it put on.

[11:45]
now .81/.83 :slightly_smiling_face:

[11:45]
Should have made this trade myself!

student
[11:45 AM]
yeah just got it at .83

[11:45]
just need to do something here to get the mechanics down

[11:46]
even if my poor paper account suffers

pat
[11:46 AM]
Yeah, it’s just the paper account (make sure it says paper account in yellow up at the top).

[11:46]
Look through your charts and just make a few trades.

pat
[11:47 AM]
Here’s another trade for you. I just mentioned the S&P in the chat.

[11:47]
SPX. but you trade it using SPY

[11:47]
Go buy some SPY July17 puts. Try and do the calculations on the risk.

[11:47]
Exit is a break above the 50-Day in the SPX.

[11:48]
also, the SPY is basically 1 point per 10 points in SPX.

student
[11:53 AM]
ok, so the next piece that I’m really fuzzy on is what do I do next. I have a GM and a SPY put order

[11:53]
how do I go about selling it

[11:54]
just click it and hit sell

pat
[11:54 AM]
Exactly. It’ll show you how many contracts you have on up in the top there in gray I think.

[11:54]
But hopefully you know how many anyway.

[11:55]
So yeah, just click sell, enter your qty and price, and do it.

[11:55]
The sell order simply cancels out the long position so you have nothing left on. The $ difference is credited or debited to your account, and that’s it.

pat
[12:51 PM]
Good chat today. Mind if I copy and paste it into a blog post? I can go through and delete your name if you’d rather. These are the types of questions that a lot of people have.

student
[1:18 PM]
I don’t care if u leave it. Thanks for the info. Really helped

[1:22]
so SPY seemed to bottom out right when we discussed it then head north hard

[1:25]
50 day is 238.58 for exit?

pat
[1:25 PM]
haha, yeah, glad we didn’t make that trade then.

[1:25]
SPX went through the 50-Day already. Would have tripped our stop.

student
[1:25 PM]
depends on what the duration is.

[1:26]
market seemed to like the net neutrality news…assholes

pat
[1:26 PM]
no, 50-day is 50-day.

[1:26]
if you change to an hourly chart then you are looking at a 50-hour line.

student
[1:27 PM]
236.68 (edited)

[1:27]
so we’ve already blown through that RIP

pat
[1:28 PM]
I just discussed that briefly in the main chat.

[1:29]
I’d still be interested in the trade tomorrow morning if we opened below the 50-Day.

student
[1:29 PM]
should i sell it now, or leave it and see if things drop tomorrow?

student
[1:33 PM]
both SPY and GM found bottoms to bounce off of.

[1:33]
is there a way to automatically set an exit so it sells if it hits it

[1:34]
I assume

pat
[1:34 PM]
There is. But you really don’t ever want to do that with options.

[1:37]
The markets are too thin, and either they’ll blow through your stop, or they’ll trigger your stop when it shouldn’t be. Maybe not in GM, but in some less liquid markets. If the bid/ask is 3.50/3.80, a market maker can see if there are other orders behind that 3.50. Maybe the next order isn’t until 3.25. So, a smart market maker could sell 1 contract at 3.50, trigger your sell stop, then simultaneously place his buy order at 3.30 so your sell orders triggered at 3.30.

[1:37]
This is not beginner level talk. :slightly_smiling_face:

student
[1:38 PM]
:mindblown:

pat
[1:38 PM]
Even if your stop were a stop limit order at 3.50 he might sell one contract just to trigger your sell stop and then he’d buy them all up at 3.50. Even though the real value at the time might be closer to 3.80.

[1:38]
This is the kind of thing we pit traders did all day long.

[1:38]
Stop Hunting.

[1:39]
It might cost us $20 bucks to go stop hunting, but if we trigger a big stop order we might make thousands.

[1:39]
it only takes one contract traded to trigger a stop. And the stop order might be for 500 contracts.

[1:40]
It’s why we don’t use stops in options.

[1:40]
In more liquid markets like stocks or futures, you can use them.

student
[1:41 PM]
got it

pat
[1:41 PM]
Market really took off. Glad I just got out of the way of it today.

student
[1:42 PM]
so its paper trading so it really doesnt matter, but if you were in my current situation would you sell to stop the bleeding? or hold out for a down turn?

pat
[1:43 PM]
I would have had my stops in place beforehand. MENTAL STOPS. And I’d already be long gone from those positions.

student
[1:43 PM]
lesson learned :slightly_smiling_face:

pat
[1:43 PM]
My stop might have been at a 20% loss on the trade, but those same trades might be down 40% now.

[1:43]
And then what the hell would you do overnight?

[1:43]
Hold on and pray that the market opened down tomorrow?

[1:43]
That strategy will bankrupt you in a hurry.

[1:44]
We take our losses in here. Take em quick and cheap, then try and let the winners make the real money.

[1:45]
GM. Remember, this is about the level I said this trade would have been better to get in at in the first place?

[1:46]
If you had entered here this morning, then rode it down, you might have taken at least some profits down there. Then as it came back up I would have exited it all at break even.

[1:47]
When a trade goes in my favor 10% or more, I generally move my stop to unchanged. Psychologically there is nothing worse than letting a winner turn into a loser. Letting it turn into a scratch is easier to take and move on from.

student
[1:47 PM]
Why doesnt Jul17 show on the bar

student
[1:48 PM]

pat
[1:48 PM]
That just means there are no July options yet. I’m not sure why they trade them that way in GM.

student
[1:48 PM]
gotcha

One thought on “Student Chat – A Basic Put Trade

  • Great lesson. Come to realize I haven’t paid much attention to volume and open interest since we buy option at the money 90% of the time.
    So repeat 10 times :
    “Volume is the number of contracts that have traded today, open interest are the number of contracts open and outstanding”. 😁

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