The Business of Investing

Investing is a business. It does not have to be your only business. In fact most investors/traders have full-time jobs that require their time and attention when markets are open. But that does not suggest that investing should be considered as a hobby.

Assuming that your trade and investment decisions are designed to improve your financial situation, then they deserve serious consideration. Hobbies are fine things that promote our emotional health. But investing is not a hobby. It deserves your full attention for whatever amount of time you decide to allocate for this side business.

Newspaper reports during the 2008-9 market decline tell us that most investors ignored (more likely were afraid to open) their monthly or quarterly reports from their brokers or fund managers to avoid reading the bad news. That is no way to run a business.

Attitude and mindsets

    –Keep a level head

      –Do not lose interest when your investments are under-performing.

      –Do not get all excited when your investments are out-performing your expectations

    –Have a plan with details

      –Profit target per trade
      –Annual profit target
      –Risk-reducing risk management ideas. Plan to exit or reduce size when loss limits are met.
      –Consider risk-reducing adjustments instead of size reduction, if you have the time to find suitable trades

    –Know your underlying asset and be sure it is suitable for you

      –Be ready. Maintain a list of stocks that meet your criteria as a sound investment. Yes, this takes time.

      If you prefer to trade indexes (or ETFs), choose one that consists of the type of stocks you are comfortable tracking. That can be large caps (SPX), small caps (RUT), or mid-caps (MID). It can be specific ETFs that track certain market sectors, but do not trade leveraged ETFs (2x and 3x ETFs).


If you have the time, plan to look at your portfolio every day, or at least every week. If your investment business gets less time than a weekly review, it is not really a business. And that’s fine for the long-term investor who is not going to be making frequent decisions. But it is not for anyone who owns option positions on a consistent basis. Those require monitoring – both to take profits and to manage losses.

The less frequently you can look at your holdings, the less risk you can afford to take. For example, if you write covered calls and only look at your portfolio on weekends, it is far safer to work with less volatile stocks. If you trade iron condors or credit spreads, be conservative when choosing position size. Be conservative when choosing strike prices because you will not be able to make timely adjustments. Thus, risk must be less when compared with traders who monitor positions frequently.

Treat your trading as a business and
–Do not hold bad inventory.
–Do not hold losing positions unless you honestly like the position in its underwater state
–Pay attention to profit targets and be ready to take profits when your goal is met
–Costs matter. Negotiate rates with your broker, or consider moving your account.
–Execution matters more. It is acceptable to pay higher rates when you believe your broker gets better fills. (Yes, this is difficult to judge.)

it is okay to have fun and enjoy trading. But it is not a hobby.


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Profit Targets

Look for a new track that trade later today.
The plan is to start a diagonal spread and to compare it with a credit spread.

Live meeting at noon CT. One hour of questions and answers.
Members received an invitation via e-mail.

Brand new option traders almost always ask: “How much money can I earn?”
That is a bad question for many reasons.

Nevertheless, trade plans require making an estimate of earnings potential. I believe it makes sense that we do not want to take risk without knowing the potential reward.

But beyond the monetary aim for each trade, or each month, is the need for a Master Plan.

The Problem

Let’s say you are a seasoned trader who is making a serious attempt to get involved with options. Perhaps you’ve dabbled in the past, but now you own a stock portfolio and are seeking a way to trade the markets with less risk and a satisfying rate of return on your investments.


If you target a non-very aggressive earnings goal of 1% every month, that is far better than anything available to the average trader in today’s low-interest world. Let’s agree that you are willing to accept moderate risk, and want to earn income by selling option premium.

You have alternatives. Writing covered calls offers the opportunity to generate income, but does little to reduce downside risk. Let’s agree that you choose to sell credit spreads. Your naturally bullish nature suggests selling put spreads (actually equivalent to writing covered calls and buying a farther OTM put as insurance). However, to have more of a market neutrality for your option portfolio, you are prepared to also sell some call spreads. Thus you find yourself trading iron condors — possibly with a bullish bias.

Let’s say that all goes well. Your basic trade is an SPX 10-point, 6-week iron condor. The premium collected tends to range from $.95 to $1.20. Margin (and money at risk) is roughly $900. Each winning trade is closed when the profits reach $0.40. Let’s assume that 5 cents covers expenses and that the remaining $0.35 represents a 3.9% return on your investment. This is far more profit than your target, but it turns out to be more than enough to cover your losses.

So what’s the problem? There is none for the disciplined investor. But human nature being what it is, most people who found themselves in this situation would want ‘more’. Instead of targeting a profit of forty cents per trade, the urge becomes to go for 50 then 60 cents. And that is a problem. The very nice, successful plan worked like a charm, giving you the income you sought and helps you maintain your lifestyle and meet your financial needs. that should be enough for anyone.

But if you become dissatisfied with ‘money being left on the table’ then it is possible to get into serious trouble. Earning 1% per month involves far less risk and can be achieved far more often than seeking 2% per month. And that is the problem.

I urge the successful trader to think very carefully about becoming more aggressive. Sure it is a reasonable decision for the right trader, but it can turn a comfortable situation into a financial difficult for the wrong person with the undisciplined personality.

Know what you need to make your financial life happy. If you achieve that, be careful about putting that comfort at risk.

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Trading Vertical Spreads. III

Part I
Part II

Today’s post continues the series on vertical spreads and discusses the choices for bullish traders.


View Video

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Short-Term Iron Butterfly

An abbreviated post from our forum:

Hi everyone,

This is something I have been trying for a bit that seems to be working pretty well. The idea is to sell an ATM iron butterfly (iron condor where the short strikes are the same for the call and the put spread) using weekly options. I open the trade on Thursday, when the options start trading so we are talking about 8 days to expiration.

The idea is to sell ATM with a 30-point wings. The desired credit is between $18 and $20. Once the order is filled I place a GTC order to close for a gain of $1.50-$2.00. If the target is hit, I want out, end of story.

The bad scenario for this trade is what happened a couple of weeks ago (fortunately I had no position): Place the trade and get a large rally on the same Thursday, followed by another large rally on Friday. I did not trade that week. To avoid this scenario I decided not to trade the first Thursday of the month when the jobs report comes out.

The trade for this week was opened on 5/30 at 11:36 am EST and is:

    Sold an SPX 1625/1655/1685 (1625/1655P, 1655/1685C) for $20.20 credit. I put in an order to close for an $18.20 debit.

By the end of day the position is quoted for $19.50 so it is almost half way there.

I will leave contingency plans (in case SPX moves too close to one strike) to each of you.

Like I said, I think best might be to just close on Friday regardless, but another option is to roll down the threatened side when it moves XX points (or whatever makes sense for you) from the short strikes turning it into a regular IC. Credit collected is high so you will still have credit left, but that will mean waiting longer if you want to exit with a profit.

sharp cocoa

This play seems interesting and worth following.
However, we should take a look at equivalent positions because we never know what insights we could gain from doing so.

Instead of looking at the position as the iron butterfly, let’s break it into two positions: we sold one put spread (1625/1655) and one call spread (1655/1685).

In turn each of those 30-point spreads is divided into three 10-point spreads

    a) Short put spread
    Long 1 SPX Jun 06 ’13 1625 put
    Short 1 SPX Jun 06 ’13 1635 put

    b) Short put spread
    Long 1 SPX Jun 06 ’13 1635 put
    Short 2 SPX Jun 06 ’13 1645 put

    c) Short put spread
    Long 1 SPX Jun 06 ’13 1645 put
    Short 1 SPX Jun 06 ’13 1655 put

    d) Short call spread
    Long 1 SPX Jun 06 ’13 1665 call
    Short 1 SPX Jun 06 ’13 1655 call

    e) Short call spread
    Long 1 SPX Jun 06 ’13 1675 call
    Short 1 SPX Jun 06 ’13 1665 call

    f) Short call spread
    Long 1 SPX Jun 06 ’13 1685 call
    Short 1 SPX Jun 06 ’13 1675 call

Third, we can pair these spreads to produce two iron condors and one iron butterfly.

We can pair any call spread with any put spreads. For our example, I’ve paired the two spreads that are farthest from the middle strike, and the two closest. That leaves the middle two as the third pair.

The Position for Risk Management Purposes

Iron condors

    a) 1625/1635P//1675/1685C

    b) 1635/1645P//1665/1675P

    Iron Butterfly
    c) 1645/1655P//1655/1665

    We own each of these positions and collected a credit of $20.20

I find this easier to manage. However, sharp plans for a quick exit, taking the nice profit and hopefully avoiding risk-management decisions.

When I look at the tree positions, I see one IC that is 20 points OTM and other that is 10 points OTM. The third position is equivalent to owning the 10-point ATM butterfly.

All these positions do well as the market is unchanged and the target is to pay a total of $18.20 (or less) to exit each – again by the target exit date of Friday, one day after making the trade. Thus, we hope sharp has already exited by the time this is published (and he did close the trade, earning $1.75).

Something different

Lets say the market moves away from the center and reaches 1675 (or 1655). We would now have one ATM IC, another that is only 10-points ATM, and even worse, a 10-point iron butterfly that has reached the ‘point of maximum loss if SPX is priced here at expiration’ range. Scary stuff.

The thought of looking to take profits here would not occur to most traders – for the simple reason that the position is underwater AND at risk.

However, the aggressive trade could consider covering the far OTM call spread from one or both iron condors. Because they are weekly options, the cost should be small. Small enough to pay it? Ah. That’s the difficult decision.

Looking at these synthetic equivalent positions, it seems to me that there is no need to go there in this instance. Looking for the quick profit from the iron butterfly seems to be a viable strategy.

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An Illusion: The Covered Straddle

A recent question from a member brings up a topic that is worthy of a full discusssion:

My initial attraction to options came when I realized the potential benefits of put selling. I’ve viewed your video on this topic, and it seems we think alike on this. One approach to put selling that appeals to me is something I understand is called “systematic writing”: namely, sell puts on one-half the position you are prepared to own; if/when you are assigned, sell a straddle for the other half; if called away repeat and if assigned under the put, sell covered calls.

A simple, but effective plan for the premium seller who is BULLISH. Never forget that this strategy does not work in a bear market. But I am certain you already know that.

It appeals to me because by working with half positions it helps avoid the position sizing problem you allude to in your video; and because it provides access to the great premium that an ATM straddle provides, without the risks normally inherent in selling a naked straddle. I would be interested in your views on this.

This is an illusion.

Half positions should not make you comfortable about position sizing. It is trading the full-sized position that must leave you comfortable. If you want to trade 10-lots, then you can sell 5 puts to begin the strategy. But if being short 10 makes you uncomfortable, then 10 is the wrong size. Yes, I know that selling only 4 to begin may leave you wanting more, but do not end up with 10 when 10 is uncomfortable. Suggestion if that applies to you, there is nothing special about 50%. You could sell 5 puts and then and 3 more later. That is not a suggestion. It is only an alternative.

I hope you are familiar with the concept of equivalent positions. Assuming ‘yes’ then you know the covered call is essentially the same position (it is equivalent; same risk, same reward) as being short a put (when the options have same strike price and expiration date). Thus, selling the ATM straddle is nothing more than: a) writing an ATM covered call on the stock you own and b) selling one more put. This time it is an ATM put.

I mention this because I find it helps to look at positions in different ways. I believe that thinking of the straddle as providing ‘great’ premium leads you astray. You merely have the equivalent of being short two puts instead of one. That is what a covered straddle is. In other words, you have doubled position size, as planned. And the premium seems to be so high because you think of the covered straddle as a single position when it is really two naked puts (or two covered calls). I don’t like the thought that you were ‘charmed’ into the covered straddle by a professional options teacher.

The reason we look at the covered straddle as less risky than the naked straddle is because it has zero upside risk. In fact it is a bullish play (short 2 puts). The investment world tends to think of being naked short calls as more risky than being short naked puts. Theoretically that is true (stock can go to infinity), but in practice when we are short a call or a put on a $100 stock, neither sale is more risky than the other when the trader pays even a tiny bit of attention to managing risk.

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Rookies Guide to Options; 2nd edition

To members,

The 2nd edition of The Rookie’s Guide to options will be available next month, June 2013.


If anyone wants a copy, let me know. The price is $27, but I can make it available to members who can provide a USA mailing address for $18.

    The cost of shipping makes it impossible to offer it at any reasonable price to members who live overseas. Even to Canada, shipping (~$15) is almost equal to the price of the book.

I would like to produce an e-book version, but there are difficulties that I cannot overcome.

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