Investools Basic Options Workshop December 12-13, 2008 Instructor Darren Kimoto

Bullish Strategies long stock long call short put long call vertical short put vertical

Bearish Strategies short stock long put short call long put vertical short call vertical

You should know at least two strategies for each market posture Neutral Strategies covered calls You should know at least two strategies for each market posture

Long Stock (Un)limited risk to the downside No time decay Delta of 1.00 May receive dividends Able to sell covered calls against

Short Stock Unlimited risk to the upside Dividend risk Can be hard to borrow Pay interest

Long Call The right to buy stock Stock substitute (less cost) Limited risk (stop not required) Pay time decay Price must move beyond breakeven

Short Call The obligation to sell stock Unlimited risk Collect time decay Do not need price to move

Long Put The right to short stock Short stock substitute (except debit) Not affected by hard to borrow Limited risk (stop not required) Pay time decay Price must move beyond breakeven

Short Put The obligation to buy stock Purchase stock for cheaper price (Un)limited risk (almost as long stock) Collect time decay Do not need price to move

Credit Spreads OTM more conservative Collect time decay Do not need price to move Want to hold for less amount of time (to mitigate risk) If wrong, you can convert to a long option If possible, allow time to decay before exiting NEVER take a max loss

Debit Spread OTM more aggressive More of a directional trade Pay time decay Price must move beyond breakeven Want to purchase enough time for price to move Exit - same as you would a long call

Debit / Credit Spreads On TOS platform, to construct a custom spread in SINGLE mode Click on first leg, then CTRL click on second leg This will construct your custom strikes Take profits at 80 to 90% of max profit ETF's are best, if using stocks, beware of earnings, dividends and news Exit bullish spreads if significant close below support, opposite for bearish Want 25% rate of return in 3 to 4 weeks ( adjust for equivalent if more or less time ) This gives you a 75% probability of success

Covered Calls Same risks and benefits as long stock (except premium on call and capped reward) OK to sell ITM covered calls on ETF’s now that bear market has dropped so much Want minimum 3% profit in one month ( adjust for equivalent if more or less time ) On call premium If called out

Finding ETF's Investools > Investor Toolbox > Funds > ETF Most liquid - SPDR, ProShares Top down - Investools > Investor Toolbox > Industry Groups > Big Chart > By Rank Choose SECTOR (not Industry Group) at the top with the most hits for bullish, bottom for bearish

Market Forecast & Market Sentiment RED line is momentum BLUE line is near term GREEN line is intermediate term (8 to 13 weeks) Follow the GREEN line to determine the trend If GREEN line and Market Sentiment agree - could be a home run Look for clusters - they work 70 to 80% of the time Super Cluster - M.F. and M.S. in same zone (+80 or -20) Look for Divergences on Market Forecast compared to underlying

Home Runs Use market forecast Monthly (very long term) Weekly (long term) Daily ( intermediate) 60min (current) Home runs occur when the long and short term trends agree ex) a short term uptrend which meets the longer term down trend These occur at a trend line or major support or resistance You can do directional trades - long puts/calls or futures

General Market Posture Do this every weekend Long, intermediate, and short term trends M.F. and M.S. Momentum indicator Be aware of limitations, (MACD, moving average not reliable when sideways) Re-check throughout the week Keep a log

Build Bullish and Bearish Watchlists Good or Bad fundamentals Good volume Good option liquidity Good option prices

The Key Questions You Must Answer Before Investing WHAT to invest in WHEN to enter HOW MUCH to invest WHEN to exit

Transition Points As the market transitions from one posture to the next, you need to adjust strategies When you notice your strategies are not working, the market is probably transitioning You need to be aware of these transition points You need to reduce open positions and move to cash at these transition points The market prices options incorrectly at transition points Premium is mostly based on time and Implied Volatility (IV) Need to understand direction, time and IV

#1 Goal - Consistency (monthly) 10% home runs Long calls/puts Futures 90% consistency High probability strategies High probability techniques Fundamental analysis Technical analysis You can make money even if you forecasted wrong

#2 Goal - Monthly Income 1% a month to start, then 2%, then 3%

Three Required Aspects of Traders Knowledge Skills Psychology Three intersecting circles within one large circle labeled K, S AND P

Knowledge Six Strategies- bullish, bearish, neutral Every strategy must have written rules with a checklist If no rules, then paper trade only Must know - what to trade, when in, how much, when out

Skills Practice does not make perfect but correct practice does Smart people learn from their own mistakes wise people learn from others mistakes Coaching Trading Rooms (at least two per week)

Psychology Discipline Books Think and Grow Rich - Napoleon Hill Secrets of the Millionaire Mind - T. Harv Eker

Top 10 Mistakes No trading plan - must have a written trading plan Improper position sizing Trading against the trend - both stock and market trends Lack of diversification- asset diversification- strategy diversification Poor risk management

Top 10 Mistakes (continued) Cutting profits short, letting losers run Setting unrealistic expectations Focusing on being right Timing tops and bottoms Impatience - leading to overtrading

Portfolio Beta Weighting To Adjust for Max Risk If your portfolio contains mostly S&P 500 stocks or options, can use SPY Obtain SPY ATR (assume 5.5) Calculate your max portfolio risk (assume 2%) If portfolio = $50,000, then $50,000 * .02 = $1000 = Max Risk Calculate SPY Delta equal to Max Risk $1000 / 5.5 = 181 = 181 SPY Deltas Now Beta Weight your portfolio on the Analyze tab using SPY If portfolio Delta exceeds 181, then you have too much risk You must decide whether you are bullish, bearish or neutral, based on conditions to determine whether the Delta should be bullish (+ positive) or bearish (- negative)

Misc Stuff Darren uses six month options on calendar spreads Long options - buy enough time plus 30 days Estimate price move and time to target Candlestick patterns to trigger an entry On long puts - exit fast at target, they bounce back quick Total portfolio invested Darren has had up to 100% during a bull market Currently has a maximum of 40% during this bear market The point of a wedge pattern is usually a support or resistance level

Bonus Thinkorswim with Scott Connor Successful Traders Use defined risk trades Use high probability trading strategies Always keep time decay their your side When calculating probability of expiring, you must use breakeven price (this can be done on the Analyze tab) Use THEO PRICE on Trade tab to forward test your trades more valid than backtesting Set first trigger OCO to set STOP and TARGET when entering trades