By: Steve Smith
As many of you know, my name is Steve but… I have to be frank… this week has been a tough one, to say the least. But, despite taking it on the chin in our PayPal (PYPL) position, Options360 is still up 53% YTD. After 30 years in business, I know when things don’t feel right. More specifically, I know enough not to revenge trade to “get it back.”
This is especially true in the current market, which has once again become a tale of two tapes; there’s the headline indices where the SPDR 500 (SPY) and Powershares Nasdaq (QQQ) are hitting new highs on the back of just a handful of mega-cap stocks — Apple (AAPL), Amazon (AMZN), Google (GOOGL), and NVIDIA (NVDA) have all had monster moves. However, under the surface, a lot of damage is being done.
In fact, when the QQQ hit a new all-time high on Thursday, there were the highest number of stocks making new 52-week lows since the March 2020 COVID crash. This is wild and weird and speaks to magic, and often misleading, market-cap-weighted indices.
Rather than predicting what’s going to happen, I’m taking this as an opportunity to bone up on some basics by reading and returning to some valuable resources. In other words, continue learning the timeless knowledge that’s available at the stroke of our keyboard.
Let’s start at the beginning; as with any tool, before using options, make sure you’re familiar with the basic rules and guidelines that govern their behavior.
For starters, make sure you know the contract specifications of the product you’re trading. Items such as margin requirements (pay special attention to leverage), the exercise and settlement procedures, what strikes, and listed trading expirations are important.
For example, be aware that index options, such as those on the S&P 500 or SPX, can only be exercised on expiration day and are cash-settled. Also, note that SPX options cease trading on the third Thursday of the month; a day earlier than equity options, though they officially expire on the third Saturday.
By contrast, equity options, including those on the Spyder Trust (SPY), can be exercised at any time during the life of the contract. This is especially important when trading options on stocks that pay dividends.
A terrific book that covers all the basic concepts and strategies is Options as a Strategic Investment by Lawrence McMillan.
The next level is Option Volatility and Pricing: Advanced Trading Strategies and Techniques by Shelton Natenberg.
Dealing in Dividends
If you own Exxon (XOM) in-the-money calls, make sure you know when the ex-dividend date occurs. You’ll need to exercise your calls if you want to qualify for the payment. Likewise, if you’re short an in-the-money call on a dividend-paying stock, be prepared for assignment and being short the actual shares the day before it goes ex-dividend.
Most ETFs pay dividends. Some, like the “Spyders Trust (SPY),” payout quarterly, and for some reason, the ex-dividend date often falls on the Thursday prior to a quarterly expiration. Meaning, many people have failed to exercise an ITM call and lose out on the dividend while others are unwittingly assigned puts and forced to pay.
Others, like the “Dow Jones Diamonds (DIA)” make monthly distributions. The point is, knowing the basic rules by which the various vehicles operate will help you avoid surprises such as an early assignment on an in-the-money call.
Options traders, like other professionals, love to use industry jargon. Talking the lingo serves several purposes: It connotes a high level of knowledge and expertise in one’s specific field, and it accurately conveys complex concepts in a concise manner. Also, it just sounds so cool to say things like, “I’m long vol up the ying-yang and bleeding theta,” which basically means one owns options that are suffering from time decay.
The downside of lingo is that sometimes it’s used to purposely conceal the true level of understanding, or is simply a means for the speaker to bolster his self-esteem and get the upper hand in a conversation or negotiation.
This can be very off-putting to the layperson put in the position of deferring to the expert because he’s reluctant to ask a “stupid question.” So, with that in mind, while it’s unimportant to know all the jargon, it’s imperative to understand the concepts so you don’t make a needless costly error.
Or, that scalping gamma is a fancy way of saying, “I’m trying to buy low volatility and sell higher volatility as the price of the underlying stock moves back and forth within a trading range.”
For deeper dives into it, there are plenty of good books out there.
One of my favorites on harnessing Vega and Gamma is Options Volatility Trading: Strategies for Profiting from Market Swings by Adam Warner.
A great site for finding and analyzing current and historical volatility, along with an amazing amount of free tools, is iVolatility.com
Some of the best option books I’ve ever read come from Charles Cottle whom I’ve had the pleasure of sharing a panel with on several occasions. His Options Trading: The Hidden Reality blew my mind so much so that I had to go back and read it again. I still only understand half of what he was saying.
For more timely market insight and trade ideas here are a few of my favorite Twitter follows:
Have a restful and reinvigorating weekend.