Options Trading Rules

Front 1

Risk Management - 25% Rule -

Back 1

--No more than 25% of your positions should hold the "prospect" of a “greater than max loss of 2%.” Thus, if you have 8 positions, only 2 of them can prospectively or possibly exceed the 2% rule per position.

--0% chance for disaster.

Front 2

Risk Management - 2% Rule -

Back 2

--Generally max risk per trade should be no more than 2% of the net liquidating value of the account.

--If you are entering a trade that has more exposure than 2%, then go at least 30 days out.

--Reset 2% limit each month; however, as net liquidating account value decreases, decrease bet size accordingly using 2% of current NLV.

Front 3

Execution - Scaling Out -

Back 3

--Take off 1/3 at the 1.272 extension.

--Set profit stops at 80%, especially on weeklies.

--Profit stop first target should be 50% gain for 1/3 of position; second target is 100% gain for 1/3; last 1/3 hold onto for squeeze loss of momentum.

--Stop loss on option is 50% of the value.

Front 4

Risk Management - 15% Rule -

Back 4

--Max exposure should never exceed 15%; thus, if all positions failed, then NLV should not fall more than 15%.

--Thus, 7 positions at 2% max risk per trade is the limit of the 15% rule.

Front 5

Risk Management - Spread the Bets -

Back 5

--Do not to overly focus bets in one trade group, like technology.

--Consider spreading among long and short positions, resilient stocks that are not as subject to market moves, and non-correlated products, like TLT.

Front 6

Risk Management - Hedging - Part 1

Back 6

--Analyze beta weighting of positions versus SPX.

--Use correct hedges based on the following:

a.1 SPX option=10 SPY options =2 Emini Futures

b.1 NDX option=40 QQQ options=8 NQ Emini Ftr

c.1 RUT option=10 IWM options=1 TF Emini Ftr

-- 7 delta 70 SPY put options dropping 1 point = +$500

--If you are going to lose $1,000 NLV if SPX moves down 10 points, set up hedge accordingly so you are flat, meaning NLV doesn't change.

--Close hedge when it is profitable, don't wait.

Front 7

Risk Management - Hedging - Part 2

Back 7

--If a 2% move in the SPX would result in a $10,000 loss to your portfolio, then you can hedge with 5 ES contracts (2% move in SPX = 40 points. 1 ES point = $50. $50 x 40 points x 5 contracts = $10,000).

--Or you could use 25 SPY Puts, etc. Just know this in advance, and if you get an opposing signal, you can put it on and then take it off.

Front 8

Execution - When to Buy, Sell, Reload

Back 8

See Diagram 8 Squeeze phases.

Front 9

Execution - When to Buy, Sell, Reload

Back 9

--1.Squeeze Triggers. Initiate first directional positions (buy 70-80 delta options 30 days out and (possibly) sell 20-25 delta options if stock IV is <30%; or sell ATM spreads 7-14 days out in high IV >30%; combo of both). Analyze in connection with expected move.

--2.Squeeze Fires. Trade Management (sell diagonals; spreads; lock in portions of profit); squeeze lasts 8-10 bars of chart used. Squeeze may permeate 1 std deviation and beyond expected move.

--3.Wrap up directional trades and (possibly) initiate income trades (sell call spreads) or directional (buy put spreads). When momentum shifts by two bars in a row, time to exit directionals. Analyze in connection with expected moves. Remember to sell when prices reach 80% of max profit.

Front 10

Execution - Earnings - Beyond the Exp. Move

Back 10

--If the stock moves up after earnings beyond the expected move, expect continuation the next day to the upside, especially if heavily shorted (review percentage short).

--Target next day will be prior evening high, which stock likely will return to the next day.

--Look for early morning or early afternoon squeeze on the 5-minute chart.

--Sell ATM put credit spread and consider buying a few out of the money calls.

Front 11

Execution - Psychology -

Back 11

--See diagram 1 of stock movement based on psychology.

Front 12

Market - Put/Call Ratio - >= 1.0 Is Bullish

Back 12

--On a daily chart, a 10 day simple moving

average nearing 1.0 or above signals that

there is “too much fear” in the markets and

everyone is hedged. At this point, there is “no

one else left to sell” and the markets start to

bottom out. Thus, mkt. likely will head higher.

--Between 0.75 and 1.00 is neutral.

Front 13

Market - Put/Call Ratio - =< 0.75 Is Bearish

Back 13

--On the opposite side, on a daily chart, a 10

day simple moving average nearing 0.75 or

below shows that everyone is bullish and

long. Meaning there is no one left to buy.

The markets roll over and start taking out

stops. Thus, mkt. likely will head lower.

--Between 0.75 and 1.00 is neutral.

Front 14

Market - $TRIN - 0.5-2.0 -

Back 14

-- Closing reading over 2.0 typically results in

a bounce the next day, if not over several

days.

-- Closing reading under 0.50 results in

sideways to down movement next day to

several days.

Front 15

Market - $TRIN - Diagram

Back 15

See diagram 9.

Front 16

Market - VIX - 17% or greater

Back 16

--Vix rising to 17% or more indicates a sell off. In that case, buy hedges.

--Vix falling from above to below 17% suggests it is time to buy or get long the market.

--If Vix closes above or touches upper bollinger band, look for snap back in the market (esp. if 2 days in a row). Opposite is true-if at bottom or below, anticipate a sell off or stall out. Diagram 12.

Front 17

Execution - Market Trend -

Back 17

--Don't anticipate price; participate with the trend.

--Trade the trend.

Front 18

Execution - 21 Day Moving Average -

Back 18

--Price always comes back to test the 21-day moving average.

--Consider price movement relative to 21-day moving average in connection with average daily range over the past 21 days (average true range).

--Too far away from the 21-day moving average is usually equal to 2x the average true range. See Diagram 13.

--Use Keltner Channels to plot ATR using 21 and 2

--If stock comes to 21-day MA and can't get through, it bounces off, returns to channel low or high. If it gets through, might travel to top or bottom of channel.

Front 19

Execution - Using Average True Range

Back 19

• There are only 3 areas on a price chart, then, where taking action is appropriate:

– At the 21 period moving average

– 2X the ATR above the 21 period moving average

– 2X the ATR below the 21 period moving average

• All other price points are random noise. Stay out of the random noise.

• Hint: This means you can plan ahead with limit orders to execute trades at these levels.

Front 20

Execution - Psychology -

Back 20

--Keep it simple - If you are losing money, you are wrong - Get over it and move on

--You only job is killing trades that ain't working

Front 21

ETFs

Back 21

• TLT (bond futures = ZB, ZN)

• FXE (euro forex/futures = EURUSD/EC)

• SLV (Silver futures = SI)

• GLD (Gold futures = GC)

• USO (crude oil futures = CL)

• UNG (natural gas futures = NG)

• FXY (Japanese Yen futures = JY)

• SPY (S&P 500 futures = ES)

• DIA = YM, QQQ = NQ, IWM = TF

• UUP = us dollar index

• List of actively traded ETFS:

• http://etfdb.com/compare/volume/

Front 22

Execution - Position Sizing -

Back 22

• If the trade setup meets 5 out of 5 of the criteria, then you can do FULL SIZE position. TURBO. 25 Delta options.

• If it meets 4 out of 5, then do ¾ size

• If it meets 3 out of 5, then do ½ size

• If 2 or below, PASS ON THE TRADE

Front 23

Execution - Charting -

Back 23

• If you are a swing to position trader, then you can use daily, weekly and monthly charts. Day trader? Then 5 min, 15 min, and 60 min charts. OR any combination in between. For scalps, 1, 5, and 15 min. For multi day trades, 60, 120 and 240 min.

Front 24

Market - SKEW - Diagram

Back 24

• When SKEW gets over 135, market will crash; SKEW gets low, market is positioned to rally. SKEW measures perceived risk of a move 2 standard deviations or more.

• That is, “a market crash.”

• The value of SKEW increases as perceived “crash risk” increases.

• Historically the range has been between 100 and 150, with an average value of 115.

Front 25

Execution - Squeeze -

Back 25

--Presence of squeeze means 7/10 times stock is likely to fire direction of squeeze.

--Depending on squeeze (daily, weekly, etc.) suggests higher probability of a movement beyond options market's expected move of 1 std deviation (32% chancing of touching) for that time frame. If daily, then weekly move.

--70% of the time moves stay within the 1 std deviation.

Front 26

Execution - Trade Set Ups - Std.

Back 26

See hand diagram 6 of Squeeze trade set ups.

Front 27

Execution - Trade Set Ups - Turbo

Back 27

See diagram 7 of Turbo set up.

Front 28

Execution - When To Sell -

Back 28

• Also, the initial thrust typically lasts the first 4 bars after the signal fires.

• This is often where a key extension level or THE EXPECTED MOVE is located. Which is why the stock pauses here . . . And potentially gets rejected.

• Four bars into a squeeze is a great place to take your first target and then trail up your stop at breakeven.

• Note – if for some reason the trade isn’t profitable by bar 4, and your stop hasn’t been hit yet, GET OUT!

• Eight bars is a great place to take profits or at least tighten up your stops.

• I’m also a huge fan of using the 1272 and 1618 Fibonacci extension levels as targets.

Front 29

Execution - Sale Considerations -

Back 29

• Remember the average squeezes lasts 8 to 10 bars. So for a daily squeeze that is 8 to 10 days.

• For a daily squeeze, the expected move is typically hit within the first 4 days (bars) after the signal has triggered.

• Or if you aren’t near the expected move you SHOULD GET OUT OF YOUR DIRECTIONAL OPTIONS AND ONLY KEEP THE PREMIUM DECAY POSTIONS.

Front 30

Execution - Earnings -

Back 30

• An out of the money delta 10 option means that the stock has about a 10% chance of reaching that strike price, based on statistical models.

• THIS INFORMATION IS PRICELESS WHEN IT COMES TO SELLING OPTIONS RIGHT BEFORE AN EARNINGS ANNOUNCEMENT!

Front 31

Execution - Earnings -

Back 31

• A stock will be contained within a 1 standard deviation move about 68% of the time.

• This means that delta 32 options, if you sell them, will expire 68% of the time.

• Bonus – delta 30 strikes, for this reason, often represent hidden support and resistance on the charts.

Front 32

Execution - Home Run Set Up -

Back 32

• Potential home run trade? Is it ok to include a few delta 20 options on a setup for a potential home run?

• Yes on special occasions only. Squeezes on daily and weekly charts at the same time? Then yes. Otherwise the only other potential is after earnings.

Front 33

Market - Put/Call Ratio

Back 33

See Diagram 10.

Front 34

Execution - Trade Set Ups - 1 - 2 Days Trade

Back 34

--Signal is taken off the hourly chart. See diagram 2.

--Has to be in alignment with the daily chart.

--BONUS - if its also in alignment with the weekly chart.

--Buy delta 70 calls

--Stop loss TWO TIMES the 14-period ATR; see also 50% of option value stop rule.

--Profit stop - If stock moves 1.75%, start scaling out; can set pre-set option sale at .70 (delta) x 1.75% x stock price.

Front 35

Execution - Trade Set Ups - Day Few Hours Trade

Back 35

--Criteria: There is an established swing high or swing low on the stock based on DAILY CHART (see diagram 4); we are approaching that high or low swing.

--There is a squeeze setting up on the 15-minute chart.

--Target is the 1.272% extension of that swing.

--See Diagram.

Front 36

Execution - Trade Set Ups - Daily Squeeze Fires

Back 36

--See MA diagrams 3a/3b. Squeeze fires long on daily chart.

--July options have 1 week before expiration.

--Two options: 1. Buy delta 70 July options and if trade still valid at expiration, sell July and buy August; or 2. just start off buying Aug.

--Exit on loss of momentum; see diagram.

Front 37

Execution - Trade Set Ups - Earnings

Back 37

--See MA diagram 5--MA shot up after earnings, then pulled back.

--Squeeze set up on 5 minute chart.

--Target is the 1.272 extension.

Front 38

Execution - Trade Set Ups - Selling Credit Spreads on Weekly Options

Back 38

--Need actively traded stock with weeklies.

--Stock is at key extended support or resistance level. Reversion bands are good indicators for this.

--NO SQUEEZE setting up. Sell credit spread at the money near top or bottom of reversion band; sell put spread near bottom. See diagram 13.

--Ideally, sell the option for 1/2 the cost of the strike you purchased. A little less is ok.

--Exit at 80% of profit on the spread.

Front 39

Execution - Trade Set Ups - IV Crush on Bad News

Back 39

--Looking for stocks gapping down on bad news or bad earnings report.

--Panic at the open - IV explodes for the first 5-10 minutes of trading.

--Sell put credit spread near the bottom. See diagram 14.

Front 40

Execution - When to Buy, Sell or Reload

Back 40

--If stock moves below 21 EMA on daily chart, time to exit.

--Feed the ducks at the tops and bottoms of the waves. When Paul Tudor Jones was asked how he does so well in the markets, he said, “I always sell too soon.”

--Ok to consider 20 delta options when both daily and weekly squeezes imbedded.

--Don't buy puts/calls or sell opposite direction spreads when stock has moved beyond the 2 ATR keltner band. Trade the trend or wait.