Hi Larry,

Thanks for including straddle candidates in this weeks report. (big help)

I have researched the candidates and I am picking two straddles that I wish to execute. I bought JCP straddle today and I am deciding now between CCU, UPS and GE. This is where I need your advice, I could buy:
* CCU 40 OCT straddle @ 8.90
* UPS OCT strangle @ 2.55
* GE SEP strangle @ 2.4

My inclination is to go with UPS or GE because those stocks could move by those points more easily than CCU. It makes me nervous that CCU has to move by 8.90 just for me to break even. Thoughts?

I looked at the trend for these stocks using stockcharts.com and I can only see 3 years of data. How far back do you go when you look at the trend of a stock?

Maggie

Maggie,

I put on the JCP straddle myself. So if we're wrong on that one, at least we'll be wrong together

As for the other ones, here are my thoughts...

GE - The bands are relatively narrow. That's good. The implied volatility (IV) is at the low end of it's range. That's good. Will GE make the movement that you need between now and September? Assuming that you're considering the 30/27.5 strangle, your break even points at the Sep. expiration date are 32.45 and 25.05. You have 108 days. So yes, I think that's reasonable. Ideally, I would like to see GE trade sideways for a couple of more days and maybe squeeze the bands in a little more, which should reduce the premium a little and set the stage for a more powerful breakout if it should occur. I would probably want to buy it if I could pick up the Sep. 30/27.5 strangle at 2.30 or better.

UPS - It had a big range yesterday, which caused the bands to widen slightly, but they are still narrow enough. And the action yesterday may be an indication that it's getting ready to breakout. IV is low. That's good. With the Oct 65/60 strangle, you have 136 days which is a long time. Your breakeven points are 67.55/57.45. Very reasonable. UPS is not a huge mover, but then you don't need a lot of movement in this one.

CCU - Very narrow bands. This stock has been trading in a narrow band for several weeks now. And the longer it does that, the more extreme the ultimate breakout is likely to be. IV is low at about 38% vs. a 52-week high of about 128%. So IV is capable of really shooting up. Yeah, 8.90 is a high price to pay. But you have 136 days, and CCU is capable of making big moves. For example, just in the last year it has a low of 20 and a high of 55. Also, keep in mind that those breakeven points only apply to expiration. If it makes a sharp move before then, the straddle could still be profitable even though it doesn't reach breakeven. Remember our Yahoo! example. It didn't reach breakeven but the stock moved fast so the straddle was up 50%.

One handy indicator that Stock Charts offers is Average True Range (ATR). It shows you how much a stock moves in an average day. Compare that with the price of the stock and you get a good indication of what kind of movement you might expect. CCU has an ATR of 1.41, which is high for a $40 stock.

Three years of data is more than enough. In fact, what happened three years ago is hardly relevant when you are looking for a move in the next 2 to 4 months. Looking back about a year is plenty long enough.

I wish I could shoot holes in your picks, Maggie. But all three look good to me. I think you're on the right track and doing very well with your analysis.

Larry

Hi Larry,

Thank you so much for your respone !

At midday today was when I had a chance to check the options market and I reviewed the charts again and decided to go with CCU. I decided I was going to buy 45/40 strangle for 5.50 (2.70/2.80) because the CCU stock price was @ $42.39 at that time. Even though yesterday the stock price was at $40 is it best to use the strategy (straddle/strangle) that best fits the stock price at the moment?

I put my order in for :
1 CCU OCT 45 CALL @ 2.7
1 CCU OCT 40 PUT @ 2.8

I put them in as 2 orders this afternoon and only one of the legs got executed - the PUT. The other leg did not get executed, I will have to put in another order tomorrow to ensure I get a CALL.

Question for you: the bid is 2.55 and ask is 2.80 for this call, is it best just to get it at 2.80? or should I wait to see what direction the stock moves in tomorrow before I put my order in. Obviously if it moves up again the premium value will rise.

I am using OptionsXpress and I did notice that you could put in a straddle order and enter the whole amount you want to execute the straddle at, so in this case it would of been 5.50, the only thing is I can't say what the limit is for the put or for the call, but then does it matter. Is it better to use this feature?

Larry what discount broker would you recommend when trading at low volumes like me being a beginner? I'm wondering if OptionsXpress is too expensive @ $14.95. I did notice you mentioned Interactive Brokers and there is also Etrade.

I now have 3 strangles/straddles on the market, would you mind if I share them on the forum and follow them through? Basically they are DIS, JCP and CCU

Maggie

Maggie,

You brought up some important issues that deserve a complete answer - brokers, commissions, entering and exiting spread positions. Whew! Those are all very important.

Bear with me, because I'm going to answer those questions in the morning when I have plenty of time. But I'll bet you're pretty happy with DIS so far. Also, JCP is off to a good start.

And, yes, please do share your positions on the forum if you feel comfortable in doing so. We can discuss them, and everybody can learn.

Larry

Thanks Larry - your a GEM (Australian expression)! Yes I am very happy with DIS and the way JCP started off, this is all very exciting !

My current positions are:
DIS OCT 20 CALL buy @ 1.00 market value 2.20
DIS OCT 17.5 PUT buy @ 1.25 market value 0.60
JCP AUG 17.5 CALL buy @ 1.20 market value 1.65
JCP AUG 17.5 PUT buy @ 1.60 market value 1.40
CCU OCT 40 PUT buy @ 2.80 market value 2.80

My understanding is to just hold for now until I reach:
* 50% profit - then evaluate the position
* 60% loss - sell the straddle/strangle
* 3rd week of Sept for DIS - sell the strangle as time decay will kick in
* 3rd week of July for JCP - sell the straddle as time decay will kick in

Thoughts?

One option is to selling the losing leg - when would be a good time to sell the losing leg? For example with DIS, how far ITM should the CALL be before I sell the losing leg? or what indicator(s) would you use to know when it is safe to sell the losing leg?

Maggie

Maggie,

Let’s see if we can address the issues that you raised…

You tried to enter a CCU straddle by placing separate limit orders for the call and the put. That’s called “legging” into a spread position. It adds an element of risk to do it that way because now you own just the put, which makes you essentially short CCU overnight, which is a volatile stock that’s trending up.

The conventional wisdom is to never leg into or out of a spread or any combination. And it was good advice when orders were physically handled in the pits on the options exchanges and you had to wait a long time to get information about your order. All that has changed. The electronic world allows us to get information easily and quickly. Also, transaction costs are much lower than they used to be (In fact, when investors realize that these kind of changes have occurred, I think option trading will just explode). So the conventional wisdom doesn’t always apply today. Sometimes legging makes sense, especially if you have a good feel for the short-term direction of a stock.

But while you’re learning I think it would be a good practice to always put your straddles/strangles on at once. In fact, I will usually do it that way myself. I may leg out of them, but I will more often than not enter both legs of a straddle/strangle position at the same time. So unless you want to be short CCU, you probably want to get your CCU call filled as soon as possible this morning at whatever price you can get. And next time enter the order as a straddle/strangle.

As far as brokers are concerned, I wouldn’t be too quick to leave OptionsXpress simply because you think their commissions are too high. I don’t currently do business with them (my main broker is Brown & Company). But OptionsXpress has an excellent reputation and their commission rates are competitive. It can be very expensive to go for the lowest commission rates if you have to sacrifice service and good order execution to get them.

One of facts of life with option trading is that commissions can be an important factor. However, transaction costs are much more of a factor when you’re just getting started and you are trading small positions. As your account grows and you can put on larger positions while still practicing sound money management, you will find that commission charges are much less of a factor. But, for right now, you just have to live with it. You may want to make sure that you wait for larger moves so that you cover your commission charges and still have plenty of profit.

Larry

Maggie,

With JCP, you just put it on I think a couple of days ago. So there’s nothing to do there yet. And with CCU, you still need to complete the transaction. With DIS, you only have a 24% profit. So I don’t think that there is anything to do there either.

As a matter of disclosure, I ended up putting DIS on as a straddle. On Monday, May 19, I could see that DIS was falling pretty rapidly. So I waited for it to trade down to 17.85 and then I bought the July 17.5 straddle at an average price of 1.90. Why July rather than October? The stock traded down to it’s lower Bollinger Band, the market is in an uptrend, and I thought the stock may rebound quickly. That turned out to be the case, and yesterday I liquidated half of my position at 4.30 for a 126% profit. My timing is not always that accurate, but it’s amazing how small adjustments in terms of straddles vs. strangles and a near month vs. a further out month can make a big difference in short-term moves.

Yes, you have correctly stated the basic exit alternatives that I mentioned in the Smart Money Report. However, those are just guidelines. It is important that you come up with your own exit strategies. Later on, you can be a little more creative. But right now, if I were you, I would establish some hard and fast rules. For example, you may want to only put on positions where you can have at least two. That way you can have a rule that where you take off half of your position at, say, a 50% profit, and let the rest ride until the month before expiration. Or, you could have a rule that says that you are going to liquidate the losing leg when it gets below .50, and you will keep the winning leg until it trades below its 20 day moving average. There are all kinds of exit rules that you can come up with that are sound. But the important thing is to have them.

As far as my suggestion to liquidate the position when it shows a 60% loss is concerned, make sure that the 60% loss represents only a very small percentage of your overall trading account. The most important thing that you can do is preserve your capital. Money management is everything in this business. And I mean everything. And you will definitely have losses.

Do this, Maggie. Come up with some exit rules that make sense to you. Post them, and I’ll comment on them. What makes sense for me may not make sense for you.

Larry

Hi Larry,

Thank you so much for your advice and guidance. It was very helpful and useful. Buying the straddle at once is an important lesson for me.

Well, today I got the other leg for CCU at market price:
CCU OCT 45 CALL @ 2.55

Now that I have a complete strangle for CCU I am going to take your advice and come up with some exit rules for the straddles/strangles. Once I have them I will post them.

Thanks again.

Maggie

Yeah, Maggie, when I saw CCU open lower this morning, I knew that you were going to come out ahead on your "mistake." It just goes to show, as far as strategies go, nothing is in stone.

Larry

Hi Larry,

I have come up with an exit strategy for my straddles/strangles. I took into consideration money management and put some scenarios together on a spreadsheet to see what my profit/loss would be including and excluding commissions. I have kept it very simple and this is what I have:

* Target Profit
I would be very happy with a 50% profit (excluding commissions) for the straddle/strangle, but I would like to learn how to let my profits run, so I am looking at exiting when the 5 day and 20 day moving average cross paths for the winning leg. As soon as the 5-day moving average starts to decline I will be watching it very closely.

Larry, do you know of a book that explains many exit strategies that could be used when trading? I have learnt to set myself % profit targets when I trade stocks.

* Stop loss
Remember I mentioned a 60% stop loss, well I have gone from 60% to 10%. When I did the numbers 60% was way too high of a loss for me too take as I want to preserve my capital. (The 10% excludes commission fees. I have on my spreadsheet what that equates to when including commission fees.)

* Selling the losing Leg
Since these are my first trades, I don’t feel comfortable selling one of my legs yet. I thought about selling my losing DIS leg, but I looked at the RCI indicator on the chart and the stock is overbought, but it clearly is an uptrend. I will wait and see and need to gain some experience before I can create some exit rules for selling the losing leg.

Thoughts ?

Maggie

Maggie,

Congratulations for coming up with some rules. Let me address each one…

Target Profit
I would be very happy with a 50% profit (excluding commissions) for the straddle/strangle, but I would like to learn how to let my profits run, so I am looking at exiting when the 5 day and 20 day moving average cross paths for the winning leg. As soon as the 5-day moving average starts to decline I will be watching it very closely

When you’re just getting started and you’re just trading one straddle (one call and one put), you’re at a disadvantage because your options are limited. For example, if you were trading more than one, I think taking profits on half of your position when the straddle is profitable by 50% would be a very good idea. But obviously you can’t do that if you’re just trading one. But in the future you will have that flexibility.

I think that your 5/20 day moving average crossover strategy is fine. I assume you mean that you will liquidate when the 5 day moving average crosses below the 20 day moving average. It will allow you to let your profits run. I’m not sure that it’s any better than simply liquidating when the stock closes below a 20 day moving average but if you’re comfortable with it, that’s the important thing. In regard to moving averages, since you are using them as a “trailing stop” to exit your position, I suggest that you use an “exponential” moving average rather than a “simple” moving average. It will be more responsive to the movement of the stock.

I’m not sure what you mean by “as soon as the 5-day moving average starts to decline I will be watching it very closely.” You’re going to be “watching” it, but what are you going to be doing about it? The whole idea of having rules is to allow you to make more objective decisions and fewer subjective decisions.

There are many books that discuss exit strategies. It depends on whether you’re talking about exit strategies in general or options in particular. As I’ve stated somewhere on this forum before, the best book on money management (which is what an exit strategy is all about) is Van Tharp’s Trade Your Way to Financial Freedom. If you want a very good one on options, I would suggest Larry MacMillan’s Options as a Strategic Investment.

Stop loss
Remember I mentioned a 60% stop loss, well I have gone from 60% to 10%. When I did the numbers 60% was way too high of a loss for me too take as I want to preserve my capital. (The 10% excludes commission fees. I have on my spreadsheet what that equates to when including commission fees.)

Getting out of your position when you show a 10% loss on a straddle won’t work. The spread between the bid and the asked price is too large for that. For example, if you buy a straddle that is 3.00 bid and 3.30 offered, you are probably going to have to pay the offer price of 3.30. The difference between the bid price and the offer price is already 10%, so according to your rule as I understand it, you would have to get out immediately.

The 60% rule that I suggested can certainly be adjusted to maybe 50% or a little less, but 10% is not doable. You are exactly right in wanting to protect your capital. That’s the most important thing of all. But you’re going to have to find some other way of doing it. For example, you are probably going to have to really be particular in what straddles that you choose. You may have to wait for one that the total premium that you pay is small enough the you can risk enough of it and still protect your capital. One thing that I would urge you to not do is to buy strangles rather than straddles simply because the premium is less. The premium is less because it takes a bigger move in the underlying stock to make money. So buy a strangle when you truly like the position. Don't buy a strangle because the premium is less than a straddle.

I know that it’s tough when you are working with a small amount of money. But we all have to start somewhere.

Selling the losing Leg
Since these are my first trades, I don’t feel comfortable selling one of my legs yet. I thought about selling my losing DIS leg, but I looked at the RCI indicator on the chart and the stock is overbought, but it clearly is an uptrend. I will wait and see and need to gain some experience before I can create some exit rules for selling the losing leg.

You’re right. Only do what you are comfortable in doing. When you say “RCI” indicator, I assume you mean “RSI.” Keep in mind, however, that RSI is merely an indicator. A stock can stay overbought for a very long time and just keep going up. RSI works best in a sideways market. So, by all means consider RSI, but don’t make your decisions solely on what it is doing.

You’re learning fast, Maggie. Keep plugging.

Larry

Thank you Larry for the advice and guidance. I am very grateful!

You have given me more to think about and my next stop from here is Amazon

Thanks again.
Maggie

Hi Larry

I am still holding onto all my positions. With JCP and CCU I am waiting for more of a price movement before I do anything.

I do have a question with DIS, my current position is:
DIS OCT 20 CALL buy @ 1.00 - market value 2.10
DIS OCT 17.5 PUT buy @ 1.25 - market value 0.55

DIS has been trading sideways in the last week and is getting close to the 20-day moving average. One of my exit strategies is to sell when 5 day moving average crosses below the 20 day moving average.

This means I will be selling the call and I was thinking of keeping the put as I have time until the option expires and you never know the stock may go down between now and expiration.

Thoughts ?

Maggie

Maggie,

Above all, follow your rules. If you have researched your rules and you are confident that they give you an edge, then follow them without hesitation or reservation. After you have made 20 trades, and your rules aren’t working like you want them to work then, and only then, adjust your rules (see Mark Douglas’ Trading in the Zone).

As a general statement about selling the profitable call and keeping the unprofitable put, I would say it depends on why you’re doing it. If it’s because your system indicates that the trend has changed from up to down then I would say that is a legitimate reason to do it.

But if it’s just because the put has become so cheap that you just want to hang on to it just in case it becomes profitable, I would say that that’s an illegitimate reason. Even though it doesn’t seem like you’re getting much by liquidating the losing leg, just letting the option expire worthless can have a negative impact on your overall returns. So unless you have a good reason to hold on to it (and you very well may), then hanging on to an option just because it doesn’t seem to be worth much is usually not a very good idea.

Larry