When the markets are trending up, you don’t worry about your investments much, but when the markets turn bearish … what do you do?

In an interview with Jeff Sommer of The New York Times in July 2010, Robert Prechter said that he is convinced that a “market decline of staggering proportions” is on its way, and that individual investors should get out of the market and into cash and cash equivalents, such as Treasury bills.

“I’m saying: ‘Winter is coming. Buy a coat,’” Prechter said. “Other people are advising people to stay naked. If I’m wrong, you’re not hurt. If they’re wrong, you’re dead. It’s pretty benign advice to opt for safety for a while.”

Read some of the latest nuggets directly from Elliott Wave International President Robert Prechter’s desk — FREE. Click here to download a free report packed with recent analysis and forecasts from Prechter’s Elliott Wave Theorist.

For more specific advice as to why now is not the right time to speculate in stocks, here’s an excerpt from chapter 20 of Prechter’s business best-selling book, Conquer the Crash — You Can Survive and Prosper in a Deflationary Depression, 2nd edition 2009.

* * * * *

Should You Speculate in Stocks?

Perhaps the number one precaution to take at the start of a deflationary crash is to make sure that your investment capital is not invested “long” in stocks, stock mutual funds, stock index futures, stock options or any other equity-based investment or speculation. That advice alone should be worth the time you spent to read this book.

1. Stocks May Go to Near Zero

In 2000 and 2001, countless Internet stocks fell from $50 or $100 a share to near zero in a matter of months. In 2001, Enron went from $85 to pennies a share in less than a year. These are the early casualties of debt, leverage and incautious speculation. Countless investors, including the managers of insurance companies, pension funds and mutual funds, express great confidence that their “diverse holdings” will keep major portfolio risk at bay. Aside from piles of questionable debt, what are those diverse holdings? Stocks, stocks and more stocks. Despite current optimism that the bull market is back, there will be many more casualties to come when stock prices turn back down again.

2. Stock Mutual Funds Will Fall, Too

Not only will many stocks fall 90 to 100 percent, but so will a substantial number of stock mutual funds, which cannot exit large equity positions without depressing prices and which have the added burden to you of one percent (or more) annual management fees. The good news is that we will finally find out who the few truly good fund managers are and which ones were heroes by virtue of being around for a bull market.

3. The Fed Won’t Be Able To Save the Stock Market

Don’t presume that the Fed will rescue the stock market, either. In theory, the Fed could declare a support price for certain stocks, but which ones? And how much money would it commit to buying them? If the Fed were actually to buy equities or stock-index futures, the temporary result might be a brief rally, but the ultimate result would be a collapse in the value of the Fed’s own assets when the market turned back down, making the Fed look foolish and compromising its primary goals, as cited in Chapter 13. It wouldn’t want to keep repeating that experience. The bankers’ pools of 1929 gave up on this strategy, and so will the Fed if it tries it.

Read some of the latest nuggets directly from Elliott Wave International President Robert Prechter’s desk — FREE. Click here to download a free report packed with recent analysis and forecasts from Prechter’s Elliott Wave Theorist.

This indicator instantly gained an enormous amount of media attention. So we sat down with Steve Hochberg, EWI’s chief market analyst and close colleague of Robert Prechter, to ask him about the now-infamous Hindenburg Omen.

EWI: Steve, recently a market indicator called the Hindenburg Omen has been in the news, what is going on?

Steve Hochberg: Discussion of this indicator certainly has been everywhere. Someone emailed us and said they even saw it mentioned on the front page of the Drudge Report! Look, headline-grabbing names grab headlines. Essentially it measures the fractured nature of market action. Over the years, we’ve discussed numerous times in our publications how a fractured market is oftentimes an unhealthy market. The multiple non-confirmations registered at the recent August 9 stock high, which we talked about in the Short Term Update, are another manifestation of this bearish behavior. The message is consistent with how we view the Elliott wave structure.

EWI: Why are people interested in this particular indicator?

SH: That’s a good question, and it speaks to a broader issue, viz., the “re-emergence” of technical analysis into the mainstream consciousness of market participants. In Prechter’s Perspective, Robert Prechter discusses the timing of the popularity of technical analysis, of which Elliott waves, or pattern recognition, is the highest form:

“In long term bull markets, no one really needs market timing because the market is always going up. This was true during the 1950s and 1960s, a period of market strength. And it has been mostly true since 1982. From 1966 to 1982, though, the market was very cyclic, so investors couldn’t sleep like babies with a buy-and-hold blanket like they do today.”

The S&P 500 has a negative return over at least the past 12 years, so investors are naturally questioning the “broadly diversified, buy and hold” stance advocated by 90%+ of investment advisors. EWI subscribers are way ahead of the mass of investors because as the bear market progresses, the media should show increased focus on technical analysis, including patterns such as head-and-shoulders as well as trendlines, moving averages and, yes, even Elliott waves, just as they did during the last great bear market from 1966 to 1982. It will be an exciting time for those with even a cursory knowledge of the technicals.

EWI: So, what are you seeing now?

SH: Obviously we cannot give away our analysis, but the wave structure is clear, the myriad indicators we keep offer compelling confirmation and the market is accommodating our forecast. If readers have any interest in what this means for not only the stock market, but also all other markets, please give us a read to see if our work might be useful in helping to formulate your investment portfolio. We think it will be a worthwhile endeavor.

Read some of the latest nuggets directly from Elliott Wave International President Robert Prechter’s desk — FREE. Click here to download a free report packed with recent analysis and forecasts from Prechter’s Elliott Wave Theorist.

This article was syndicated by Elliott Wave International and was originally published under the headline The Hindenburg Omen — Omen-ous or Not?. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

One of the more fascinating aspects of options trading is position adjustment.  Taking a trade that is not working out and transforming it into a winning position is something that seems magical, not to mention really cool.  Maybe not the sort of thing that will get you a date if you mention it at a cocktail party, but it’s pretty cool.

John Summa, Ph.D., has been teaching people about positions adjustments for years through his OptionsNerd website.  He has also authored and/or co-authored at least three books on trading of which I am aware.

What’s the Ph.D. aobut?  Well, he earned a doctoral degree in economics and is a bona fide economics professor at the University of Vermont.

There is more to say about Dr. Summa, but I don’t plan on getting carried away with that right now.  Instead, I want to get back to talking about position adjustments…

On Thursday, August 5, 2010, John Summa, Ph.D., a.k.a., the OptionsNerd, will be joining us to talk about adjusting options positions.  There is no cost to attend the presentation and if you miss it I do plan on posting a video re-play in our public archive.

Register For Dr. Summa’s Presentation on Position Adjustments

I encourage you to attend the live presentation, however.  It is a really good opportunity to not only hear what Dr. Summa has to say on the subject, but there will also be an opportunity to ask him questions.

Get yourself registered now as seating is limited.  I look forward to seeing you on-line.

Christopher Smith
TheOptionClub.com

Charles Cottle the "Risk Doctor"

The book was written by Charles Cottle.  He  has also authored “Options: Perception and Deception” and “Options Trading: The Hidden Reality,” both of which are also tremendous resources.  He was one of the founders of ThinkorSwim, the most forward thinking options brokerage at the time of its launch.

If you have been trading options for very long, you have probably heard of him.  Charles is called the “Risk Doctor,” because he is the man that professional options traders go to and he sees things in the options market that many of us cannot (yet) see.

His specialty is teaching options traders how to dissect my positions and see “Hidden Realities” that most options traders don’t see with the naked eye.

The reason for today’s post is that Charles is now preparing for the launch of his upcoming RiskDoctor TODAY program where he will explore today’s volatile market conditions, and demonstrate how to uncover amazing opportunities.

He will address how to make clever adjustments to minimize risk and capture more profit.  If you want to get a glimpse of the proprietary systems and tools that Charles has been teaching options professionals for over 25 years, you have a tremendous opportunity right now.

Charles Cottle is offering a free 5 day course based upon his book “Options Trading: The Hidden Reality.”.  You will also get instant access to four RiskDoctor videos.

Take the Risk Doctor’s Course Now

If you are at a point in your options trading that you are managing more than one or two positions, where you are struggling go gain insight into how to better manage and adjust positions, then you’re probably ready to spend a little time studying what Charles has to offer.  Taking is free course is a great way to get started.

Christopher Smith
TheOptionClub.com

There are more books on options than I can count and I have read many of them.  Some were not worth the effort, others provided some interesting insights, but only one book stands out in my mind as “the book” that belongs in every option trader’s library.

If I could only have one book on the subject of options it would without question be Larry McMillan’s Options As A Strategic Investment, 4th edition.  Alex Jacobson from the International Securities Exchange said, “Larry’s book is the bible of the options community…”  I agree.

Don’t misunderstand.  There are many other very good books and you should probably add those to your library, too.  However,  I think this one book lays the foundation for all the rest.

Options As A Strategic Investment is not light reading.  It is nearly a thousand pages of solid, weighty information.  Making your way through it requires some work.  It is worth the effort.

In 42 chapters and five appendixes, Larry covers everything from elementary definitions to advanced option strategies, from arbitrage to volatility trading, from the math behind options pricing and the “Greeks” to taxes.  And more still…

All in one book!  Incredible.

Christopher Smith
TheOptionClub.com

Just what do you have to do to learn how to actually make money in this trading business?

Well, it is actually as straight forward as any other business or profession.  A lot of confusion and distraction exist out there, though.  With so many trading websites, courses, programs, etc., it is very easy to spend a great deal of time chasing your tail…not to mention spending a good deal of your money.

I want to break this down for you without talking you into or out of any particular course or program.  We can address that at a later time if anyone is interested in my thoughts and opinions on the subject.

Trading is as much of a business as anything else.  The trouble for retail traders is that there is very little in the way of barriers to entry, especially today.  Just a few thousand bucks and your signature on an account form will have you up and running.

Why is that bad?  It’s not bad.  It’s just that because it is so easy to get started most of us forget that we are actually embarking upon a new business that will require from us what any other business would require.  We start out thinking of our trading much like one would consider a hobby.  It is fun.  There is an element of excitement.  Then there are those dreams of financial independence, commuting from bed to the spare bedroom by way of the coffee maker as a morning routine.

That is where most retail traders find themselves.  It’s a fantasy.  Light entertainment.

If you fall into that category that is fine.  Just keep in mind that what you’re doing is more like enjoying yourself in Las Vegas, minus showgirls and the free cocktails.  Then there are those who are done having their fun and want to get serious, and that is where our friend finds herself.

STEP ONE – Build The Foundation

Attend our 2-day seminar and learn the secrets to being a successful physician!  Discover how to pilot commercial airliners for fun and profit in five easy lessons!  Yeah, I’m making fun.  But I am also trying to make a point here…

No rationale person would expect to become a competent physician after a two-day seminar or a commercial airline pilot after sitting through a few lessons.  Do doctors attend weekend seminars?  Sure they do!  But that is not the foundation for their careers.

The foundation for your trading business is your education.  You need a an understanding of how financial markets work.  What markets?  Well, if you’re going to trade options on stocks you had better develop some understanding of the stock market.  Options on futures?  Get acquainted with the future markets.  Currencies?  You should have the picture by now.

Options are derivative products and their value is derived from what goes on with the underlying security and the events that take place in their respective markets.  The more you know and understand about those underlying securities and markets, the better.

Most retail traders I encounter have a pretty good understanding of the equity market and their interest lies primarily with trading options on equities.  It makes sense.  Go with what you know.

The mistake many make is that while they understand the equity market they know little about the options they intend to trade.  They have learned about covered calls, married puts, credit spreads, debit spreads, iron condors and butterflies, and all the various exotic strategies.

The trouble is that they have not taken the time to really understand what an option is and how it is valued within the market.  This is part of the foundation upon which you will build a trading business.  If your business is trading options, then know your product inside and out.

STEP TWO – Develop The Plan

Now that you have given yourself a solid foundation by educating yourself about the details of option valuation it is time to develop a plan.  You really know a lot about options now.  So what do you intend to do with them?

Remember that trading options is not an end in itself, but merely a means to an end.  We trade options to protect and grow capital, generate income, and to speculate in the market.  Want to grow capital?  Great.  Let’s sit down and start writing out a plan.  Looking to generate a monthly income?  Fine.  Sit down, come up with a plan to make it happen, and start writing.  Just speculating? That’s fine but you need to write down a plan, too.

This is your business plan.  The act of creating it is just as important as having it.  By forcing yourself to do this you force yourself to identify goals, think through how you intend to achieve them, and provide yourself a written framework within which to operate.  The plan is there to define and to guide.

STEP THREE – Test And Refine The Plan

This is the trial and error stage.  Chances are that the plan you came up with has some weaknesses, so it is best that we identify them and rid ourselves of them before putting a great deal of money at risk.  Think of it as flight testing a new aircraft design.  Let’s make sure this sucker works and fix what needs to be fixed before we put it into production.

My favorite tools for testing are back-testing and live market trading.  Hold the horses!  I didn’t mention paper trading.  Don’t tell mom, but I hate paper trading and I don’t like to do it.  It takes a long time and my emotions are completely opposite what I experience when there is money on the line.  So, I first back-test a new plan using historical data, selecting different time periods with different market conditions to see how the plan fares in theory.  I apply any obvious tweaks, test again, and continue that process until I am content with what I’ve got.  Then it’s into the market with it!

Let’s not get carried away, though.  This is now real money we’re talking about and the only experience I’ve had with this plan of mine is in simulated conditions.  Want to know the definition of “simulated conditions?”  It means it ain’t the real thing.  It’s fake.  So is paper trading.  Just ask those fighter pilots who climb into the flight simulators.  As realistic as they may be, I bet their exhaust pipes don’t pucker in the simulator like when they are executing a real night landing on a real life aircraft carrier.  Now they have skin in the game and it’s their skin!

Here’s a less dramatic analogy.  I live with my family on the west coast.  When I taught my daughter how to swim I did not walk her out into the Pacific Ocean and point her at Catalina.  We started in the kiddie pool.  She was a little nervous, but she knew she could stand up at any time and that she would be fine.  After she got used to it and had a chance to practice her basic skills we moved into the big pool.  The bottom was too deep for her to stand, but I held her and we worked on techniques like floating on her back, swimming to the side, etc.  She was building confidence and improving her skills.  A couple weeks ago I was on vacation watching her swim lengthwise across the pool, racing her friends.  She’s still not ready for the Pacific…

You’re not ready for the Pacific, either.  You have a solid foundation and you’ve got a plan that has been tested in theory.  It’s into the kiddie pool with you!  Fund an account with $5,000 to $10,000.  Less is okay, but not more.  Trade the plan with just one or two contracts.  Forget about commissions and slippage, we’re not trying to get rich here.  These are the shallow safe waters.  If you get in trouble, close the position and take your $50.00 loss.  You’re okay.  Take a look at what was going wrong, find a way to identify the conditions that gave rise to the problem, and modify your plan to deal with it.  After you start feeling comfortable, and if you can at least break-even, consider increasing your size but don’t get carried away.  Do not go from $10,000 to $100,000.  Take gradual, reasonable steps.

There is nothing about trading a large account that makes the process easier.  Larger size only complicates matters and magnifies your losses.

STEP FOUR – Trade Your Plan

Now you’re in the “Big Kid’s Pool” swimming lengthwise across it.  Everything seems to be working well, you know how to deal with the trades that are going against you, your losses are limited and your profits are frequent enough and large enough to keep you in the black. Now you’re ready to fully implement your trading plan.

Markets change and there will be times when you need to modify your approach.  When you do, if the modification is a significant departure from what you had been doing with your trading, consider pulling back on the reigns for awhile so that you can test your revised strategies as outlined above.  That written trading plan should be looking pretty worn by now from being repeated revised and referenced.  The daily routine should seem just that; routine.

How long does all this take?  Some do it in a matter of months.  Others require a couple years.  A lot depends on where you are now in terms of knowledge and experience, as well as how dedicated you are to moving along the learning curve.  The goal is achievable, however.  It just takes a clear mind, persistence, and discipline.

If you want to get some help building your own trading business, remember that we’re here for you.  Come by the Trading Room or visit our free discussion board on Yahoo! Groups.

Christopher Smith
TheOptionClub.com

Having seen success using these “Top Gun” inspired methods, Matt Buckley took the application of what he learned in the Navy one step further.  The Navy has developed a training program that can take someone who has never flown a plane and train them over a period of months to the point where they are competently piloting a high performance jet fighter and executing aircraft carrier landings at night.

The Top Gun Options training course is based upon the format used by the Navy to accomplish this rather impressive training.  It all sounds very cool and the whole fighter pilot mystique has a great deal of appeal to it.  But does it deliver?

That is the fundamental question that everyone is going to be asking, so I suggested to Matt that he might want to provide a bit more insight into what he does as both a trader and an educator.  He has stepped up to the plate.

Top Gun Options Basic Training

I was provided with the above link to pass along to members of our community.  Matt is essentially giving away a copy of what he calls their basic course or “Options Indoc.”  The offer is available for a very limited time as this is usually something for which they would charge a price.  Today, your’s for the mere asking.

Move quick on this one if it interests you.

Christopher Smith
TheOptionClub.com

I remember years back intense discussions about how people had studied Sun Tzu’s Art of War and adapted it for use in modern business.  How could a general from centuries past know anything about modern business?  Well, he didn’t.  But warfare is a competitive sport with winners and losers and Sun Tzu provided insight into how one can defeat their opponent.  Thousands of years later we were contemplating how those insights might be used to defeat the competition on a different type of battlefield.

The U.S. Navy’s TOPGUN school teaches fighter pilots how to engage others in combat and survive.  It is a highly competitive environment with definite winners and losers.  Matt Buckley knows that better than most because he was there at TOPGUN and strapped into an FA-18 Hornet flying over Iraq.

Options trading is a competitive sport.  As a zero-sum game there are winners and losers with every options trade.  Matt Buckley knows this very well, too.  After leaving active military service he entered the financial markets and became very well acquainted with options.

What makes Mr. Buckley an interesting study is that he took his experiences as a Navy fighter pilot and the knowledge he gained at TOPGUN and adapted it for use as an options trader, much like others have adapted the teachings of Sun Tzu to modern business.  Matt was taught how to identify risks, capitalize upon strengths and shift the probabilities of success, i.e., survival, to his favor.  He was also taught how to identify when those probabilities shifted against him, how to disengage, and then come back again.

As options traders we need to do the same if we hope to survive in the financial market place.  Identify the risks of an options position and have a plan to minimize those risks.  Capitalize where possible so as to provide yourself an edge.  Recognize when a trade is not working properly and learn how to disengage from that position so that you might re-approach the market from a more desirable position.

On Monday, July 5th, 2010, at 6:00 p.m. PDT / 9:00 p.m. EDT Matt Buckley is joining us for a free on-line presentation to share with us some of his insights about options trading.  Come join us and discover how a TOPGUN fighter pilot sees the market and what skills he brings to the table as a result of his experiences and training.

Register For The Presentation

Our on-line presentation platform can only handle so many people.  If you would like to attend I suggest that you register yourself now, so as to be certain that you have a seat.  We do plan to start promptly and it does take a few minutes for the the log-in process to complete, so you should plan on arriving at least 5 to 10 minutes early.

The plan is to go for about an hour and we will take as many questions as we can at the end of the presentation.  During that hour Matt Buckley will share the insights he gained through his training as a Navy fighter pilot and how he uses those insights to achieve some very respectable results in the options market.

I hope you can join us!

Christopher Smith
TheOptionClub.com

This is the sort of question I receive on a sufficiently frequent basis that I decided to blog publicly about it.

First off, OptionVue has been around for many years and does a nice job but it is expensive.  There are other analytic programs and services out there, however.  For example, another way to go is to open an account with ThinkOrSwim and use their trading platform, which is very good and is essentially free if you have an account with them.  Most of us wind up fiddling with a number of different programs until we find the one or two we settle in with.  As for me, I have somewhat settled in with both ThinkOrSwim and OptionVue.

As far the ambition of generating a 1.5% to 2% monthly return, I do think it is within the realm of practical possibility.  You’re essentially talking about an 18% to 24% annualized yield.  To do that consistently is going to take some real work, but I think it is a reasonable goal to set for one’s self.

Here’s the thing, though…

The software isn’t going to get you there.  It’s just software.  It’s just a tool.  I have a hammer.  A couple of them in fact.  I even have nails.  There is no way I’m going to be able to build a home for myself.  At least not one that I would want to live in and definitely not over this weekend or even next weekend.  There is a lot I would need to first learn and I would want to gain some construction experience before trying.

Worrying about what options analysis software you are using is like me worrying about which hammer to buy.  Sure, you want a good tool but what is really going to determine whether you achieve your goal is a combination of your knowledge, your discipline, and your experience.

Learn how options work, how they can be used in various strategies, etc.  Develop a disciplined approach to analyzing the market, researching and planning trades, and executing on a well thought out trading plan.  Gain experience by first paper trading or back-testing to test your theories and develop some “virtual” experience.  Transition to trading a small amount of capital, using 1 or 2 contract positions simply with the goal of gaining experiencing.

Can you break even trading that small account?  If not, don’t increase your size because you’ll only manage to create larger losses where you now have small losses.  There is nothing about trading a big account that makes the trading easier.

If you can break-even in a small account you can then consider increasing the size a little and stay there until you can get and remain profitable.  Continue the process of gradually increasing your capital until at “full size,” but with the understanding that if you start losing money you immediately scale back.  A tedious process, yes.  Nonetheless, a far superior route than putting all your capital at risk and watching it swiftly disappear.

Should you commit yourself to acquiring the necessary knowledge and developing an options trading skill set in such a fashion you’ll find that the software is of secondary importance.  Sure, having good tools available is a good thing but do not fool yourself into believing that they will make you profitable.  Only you can accomplish that.

So, which options analysis software is best?  That is largely a matter of opinion, but what I do know is that no software program will improve your trading results without you first making an investment in yourself.

Christopher Smith
TheOptionClub.ccom

We are going to move beyond discussing a single options strategy and take a look at a fully integrated trading plan.  What am I talking about?

Well, have you ever traded credit spreads?  Sometimes, maybe most of the time, they work out great.  Sell the spread.  Watch it expire.  Keep the credit.

But what happens when that spread winds up in-the-money?  If you do not have a good answer for that question, then you owe it to yourself to attend our next live webinar event.

Thursday, March 11, 2010
9:00 p.m. EST (6:OO p.m. PST)

This presentation is going to be a bit different…

It’s focus is a method that uses different options strategies to respond to changing market conditions.  So, if you put on a trade expecting the market to do “X” but instead it does “Y”, you have a response that will move you into a hedged position ready to turn the change of market condition to your advantage.

I think you will find that you already know most of the parts, but that you will be impressed with the manner in which they are being assembled to create an intelligent approach to using options to limit market risk and to take advantage of changed market conditions.

Be Sure To Download The Complimentary E-book

First of all, you will want to download a copy of a 100+ page book  that is being made available to you.  It covers some basics, but also gets into some fairly advanced subjects.  Just a word of caution, you may not be able to ready the entire book before Thursday’s presentation.

Download The E-book & Register For The Webinar

Use the link above to download the complimentary e-book.  When you do, you will also be able to register for the live presentation.  There is no cost for either the book or the presentation.

Also, I spoke with my friends at MarketTamer and they have agreed to host the video replay of the event on their server.  That eliminates the storage and bandwidth issues I have when I put these on my server.  They’re taking care of everything!

So, what is this training session going to do for you?

For starters, it is going to demonstrate a risk averse method for getting into the market and then follow-up with an intelligently thought out trading plan.  It should be truly “eye opening” for many who attend.

Get yourself registered and download the complimentary e-book.  Then make time to attend the live presentation or catch the video re-play.

Christopher Smith
TheOptionClub.com

So, we brought in a real trading professional to tackle the subject!

The truth is that calendar spreads can make and lose money in two ways.  Price movement is one.  If the underlying stock or index’s price moves outside of your spread’s break-even points you gotta do something or you’re gonna lose money.  But if it behaves, it’s literally just a matter of time and you’re bound to turn a profit.

Implied volatility is another factor working either for us or against us.  Calendar spreads are long vega trades, which means that they are exposed to changes in implied volatility.  If it rises the value of our spread will rise and if it falls it’s going to hurt us.

The upshot of this little discussion is that understanding implied volatility, its effects upon long vega trades like calendar spreads, and a plan for responding to changes in implied volatility are good things to know about.  That’s what went down on Wednesday.

Hopefully you were on-line with us.  If not, you can still watch the video re-play which is now available on our website.

Dan Sheridan and Managing Calendar Spreads When Implied Volatility Drops

By the way, if you are a member of my Trading Room you can download the full resolution version of the video from the download section.

Christopher Smith
TheOptionClub.com

Christopher Smith, B.B.A., J.D.

I spent this weekend in Burbank, CA, with John Summa, Ph.D., learning and teaching about options.  The center piece of the weekend was a set of adjustments that Dr. Summa had worked out for the purpose of adjusting an iron condor spread.  A lot of people, myself included, have learned to adjust iron condor spreads using various techniques and I have found that those techniques have a great deal of similarity from one iron condor trader to the next…

What I found interesting about Dr. Summa’s adjustments presentation were the case studies that followed…

From the first case study on we saw actual adjustments made by Dr. Summa to iron condor positions that were actually traded by him, last year.  Last year was not an easy year for iron condor traders, so there were quite a few examples of adjustments actually being applied.

The interesting thing was that the adjustments actually used were often modifications of the techniques that were taught.  Dr. Summa explained that income trading is not a mechanical process and that there is an art to this craft.  What that means is that while we do have rules and we do need to follow them, we also need to think critically and exercise our skills as traders.

If we could boil income trading down to a static rule set we could then program that into a computer system and turn that computer system loose on the market.  Our job would be done as the computer would dutifully apply the rules mechanically, without fail.  This system does not exist, however.  Why not?

The reason our automated income trading system does not exist is for the same reason we have not yet heard of an electronic system producing great art.  Something organic is required.

We do need to build the box with its right angles and straight lines because that is what provides us with structure.  Those straight lines and right angles are the rules by which we are guided in each and every trade we execute.  We then need to learn how to think outside of that box.  Not to violate our own rules, but to adapt them to the situation before us.

The guiding principle is that which was laid down by Warren Buffet for his own application.  “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.“  All of the various option strategies you hear about, the adjustment techniques, all those fancy and often confusing names will do you absolutely no good as an options trader unless you absorb this commandment.

John Summa understands this rule of rules and has learned to bend those other rules that follow to serve the first.  Do not lose money on your trades.  As options premium sellers we tend to settle for small profits while risking much larger potential losses.  Novice traders are often pushed to the sidelines with busted accounts because they had not yet appreciated this commandment for successful traders or, at least, they did not know how to apply it.

It’s all about not losing money on your trades.  When the market moves against you, action is mandatory.  To respond to those unsettling market moves you will need a toolbox with several defensive tactics.  Dr. Summa provided those tactics over the weekend.  He then demonstrated that a bit of creativity doesn’t hurt either.

The reward for mastering this discipline is a stabilization of your equity curve.  Eliminate the breath taking drops in account value and replace them with a steady upward ascent.  It makes for a much smoother ride.

We had several members from TheOptionClub.com community in attendance.  I always find it rewarding to meet people face-to-face after corresponding on our message boards for several months, or even years.  Thanks for coming out!

Christopher Smith
TheOptionClub.com

Last night during our live group trading session in the Trading Room, that question was raised.  Of course, no one really knows what the market will do on any given day, but it is possible to get a sense of where it is likely to open.

Futures contracts on the major indexes are traded prior to the U.S. markets opening.  You can get live futures quotes from your broker or even by tuning into CNBC, Bloomberg, or the Fox Business Channel.  For example, the ticker symbol “/ES” is the E-mini S&P 500 and “/YM”  is the e-mini DJIA.  If you have access to quotes from other world exchanges you may also get a glimpse into the market activity elsewhere in the world.  Some of our members have found the DAX to be fairly reliable in predicting opening activity on U.S. exchanges.

It is sometimes nice to have an idea of what you might expect once that opening bells sounds.  As I type this, the futures are pointing toward a higher open which may provide a bit of welcome relief for some traders.  This may provide an opportunity to exit a troubled position.

Just bear in mind that a higher open does not necessarily mean that we will also have a higher close.  The market is an uncertain creature and if you ever find yourself thinking that you know what it is going to do next, that’s when it will do the unexpected.

Stay hedged.  Trade well.

Christopher Smith
TheOptionClub.com

As traders we can pay attention to the macro-economic issues that confront us as a country and that impact upon our economy, but our real job is to pay attention to the market and manage risk.  The image is a daily price chart of the S&P 500 following Friday’s market close.  You will notice that Thursday’s price action took the S&P 500 directly to the 50-day moving average, which was then decisively breached on Friday.  Our first Fib level is at 1,038, which is also a prior support level.  If we breach this level the 200-day moving average will not be far away and will likely be the next bear target.

There is little doubt that the market is now correcting after a near 10-month market rally.  The more difficult question is whether this will be a “normal” correction with a resumption of the upward trend or whether it is a harbinger of something more troubling.

Of course, no one knows the answer to this question although many will offer their opinion.  Traders need to be more pragmatic, however.  The trend is changing and whenever a change in trend takes place there is an opportunity to make and to lose money.  If you have managed to maintain profitability during the past ten months, you do not necessarily need to make money during this corrective phase.  The real objective is to maintain disciplined risk management and to minimize losses.  In other words, let’s not give back the profits we have earned.  That is the focus we have in the Trading Room.

For those of us who like to follow trends, it may be time to begin raising cash and adopt a “wait and see” posture.  Maybe we move lower from here.  Perhaps we simply consolidate for awhile before returning to the prior bullish trend.  Maybe we will be range bound.  I don’t know what direction the market will take, but I do know that if I am able to preserve capital during these transitional periods that I will be well situated to take advantage of the new trend once it emerges.

Christopher Smith
TheOptionClub.com

Yes, I am a Swimer…

What got me blogging this evening was a short article found on page 40 of the Winter 2010 edition of thinkMoney.  The article, written by Tony Battista, tackles the idea that the options market is a “zero sum game.”  What is a zero sum game, you ask?

A zero sum game is one where for every winner you must also have a loser.  In the context of trading it means that for every person who turns a profit someone else must suffer a corresponding loss.  By way of example, if I sold a call option to you and the market rallied wildly higher, you would have made a tidy profit and I would have suffered a demoralizing loss.

True?  Well, let’s consider what Mr. Battista has to add to the discussion…

Tony Battista presents three myth busting scenarios.  The first is a situation similar to the one I just offered, and Mr. Battista suggests that perhaps I would not suffer a demoralizing loss despite having sold that call option.  If I was a market maker I would immediately buy stock to hedge the risk I took on when selling the option and would have suffered no loss as a result of the market rally.  As a retail investor I may have sold that call option as part of a covered call trade; i.e., I bought stock, too.  If this were the case we both could make money, no?

What if the market falls?  You would certainly lose money on your long call, while I make money on the opposite side of that position.  But, I also bought the stock and the losses on the stock may quickly exceed the premium I received from the call sale.  In that case, you and I would both be holding our hand in the shape of an “L” on our foreheads…

We could also both be winners if I owned I profitable long call, sold that call to you to close the position and lock in my profit, and then you enjoyed a profit from a continued market rally.  But, what of the fella who sold the call to me?  Well, if that fella was a market maker she, or he, would likely have immediately hedged that short call position to offset their risk.  From market maker, to me, on to you…  Who lost money?

Well, that’s not the entire picture and true to his floor trader roots, Tony Battista does hedge his thesis a bit.  But, it was an interesting quick read that I thought I would share with my readers.  If you would like to read the original story, it is on page 40 of the current thinkMoney magazine and is available in electronic form on ThinkOrSwim’s website.

Christopher Smith
TheOptionClub.com