In our SMBU Daily Video, learn about A+ options trades.
- Not all conditions are optimal for all options income trades
- It makes sense to increase capital on trades when optimal conditions exist for that strategy
Hi I’m Seth Freudberg, I’m the director of options training here at SMBU in Manhattan and I’m also the head trader of SMBU’s options trading desk. So this week I’d like to talk about a concept that you usually hear in the context of day traders but it has an application for options income trading as well, and that’s the concept of an A+ set up. So in day trading in every trader’s a little bit different and there are certain trading situations that they seem to trade better than others.
On the equity side here at SMB the intraday equity traders also known as day traders they have this concept called your A+ set up and everyone here at SMB creates their own playbook of trades and in detail explains how they will handle each trading situation and there’s certain trades that they seem to trade better, and they’ve done back testing or they through experience they know they’re going to trade particular situations very well, and they are encouraged on the equity side here to double or triple their risk size for a what they call their A+ set ups their best trades, the trades that they are confident in, the trades they most successful with.
So I was thinking about whether this concept is applicable to options income trading which as you know is very different nature than day trading in that we make money when the market doesn’t move, so how could you have an A+ set up in in a trading strategy where the market does not move and the answer is there are there are a number of cases where that’s is so, so let me give you a couple examples.
Let’s talk about the Bearish butterfly, the Bearish butterfly is a strategy that we share with the world here at SMB it’s a strategy that many of the traders on our trading desk trade, it basically involves placing a butterfly spread behind the market and then if the market rallies you keep adding butterflies behind the market and if the market sells off than the butterfly you sold is
gonna get more valuable you have multiple butterflies on they will get more valuable and it’s a very very high-quality trade, it’s a terrific trade with a great return associated with it typically. So what we have found is that through some analysis of the market that if the Russell 2000 index increases over 60 day period by a certain amount there is a tendency for the Bearish butterfly to have a much higher probability of success than if it does not increase by that amount over
a sixty-day period. The basic principle is pretty simple if your trading a trade that does best under bearish conditions than if a rally goes on for a very long time, typically there’s a pullback the rally gets long in the tooth so to speak and you’re going to make more money you’re gonna make money more consistently if the market has rallied for an extended period of time over 60 day period. So you can see this chart here the Russell 2000 back in November of 2014 you can see that the market hit a point where it had rallied substantially and you know right around the top there would have been a point that would have triggered some interest among various butterfly traders because of some studies that have been done and sure enough the market did stall there and actually sell off a bit which would be great conditions for a bearish butterfly.
The same thing actually happened earlier this week where the market had rallied to the point where it might not be the worst time in the world to put on a very butterfly so that was an and in fact a number of the traders on our desk did initiate bearish trades this week so you could argue that that’s an A+ that would be the equivalent of an A+ set up for an options income trader, and so you could argue that under those circumstances let’s say you trade the Bearish butterfly every month no matter what in a in an A+ type of setup where the where the market’s rally for quickly over 60 day period then you may want to add some size to that treat you may want to double or triple your typical size to the bearish butterfly because it’s an A+ set up for you so that would be one example a second example is a very different kind of trade one of the guys on our trading desk here who trades both equities and he trades on our options trading desk Joe Murry has developed and iron condor trade what you might call a set it forget it trade. He puts it on 45 days out from expiration and he just doesn’t touch it either wins or loses and through some statistical studies he’s done it really worked out very well for him and what Joe found in his study was that when the market volatility increases to near 100% the 100th percentile for the moment to volatility range of that particular stock or index over the last 12 months that that is a very high probability set up for one of these iron condor trades and the reasoning is kind of easy to understand, when the market volatility gets very high which typically happens in a sell off then that usually is the peak of the volatility of somewhere around that point and eventually the market kind of settles down and the fear comes out, the volatility comes out of the options and it’s usually a high probability trade. So that would be another example where volatility has gotten to the 100th percentile of the last 12 months or whatever your trading then that could be with certain trading strategies a signal that you’re in an A+ set up and you may want to increase your size.
So just think about it, if when you have the highest probability of making money you have the most capital in the trade, that should improve your returns over time as an options trader and that sounds like to me a pretty good idea to think about seriously. So think about what are you’re A+ setups what are the situations where you’re trading the best as an options income trader what are the circumstances where when you look back you realize well every time that particular combination of events occurred I made money it wasn’t a fluke there was a logic behind it there was a reason behind why made money, those might be the times you want to size up a little bit, increase your capital level and improve your returns over time on your account. So give that some thought and we’ll see you next week thank you.
* no relevant positions