OAP 144: Interview w/ Larry Connors – Buy the Fear, Sell the Greed Book Review

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On today's podcast we bring in a very special interview guest, Larry Connors, and discuss his new book Buy the Fear, Sell the Greed. Larry is an established author in the trading and equities space and I thoroughly enjoyed our conversation about market dynamics, trading psychology, VXX pricing structures, and the future of the industry with regards to automation. As you listen to this podcast interview, notice the very similar structure and thought process that both Larry and I share about creating mechanical data driven event signals that can be replicated in any market environment. This I believe is why traders who use a more systematic approach end up performing better than those who are driven by their emotions and psychology of the environment.

Key Points from Today's Show:

  • Larry is one of the authorities in the options and trading space.
  • He has authored 7 books, including his latest book, Buy the Fear, Sell the Greed
  • Larry looks at trading in a very systematic fashion, which matches to what we try to do as options traders.
  • His perspective gives a lot of parallels to options trading and another way to understand how markets work.

Interview Discussion Points:

  • In this interview, we cover Larry's history and how he got into trading.
  • Discuss the bond-trader story and the opportunity that arose during Brexit
  • We also talk about VXX pricing and how to take advantage of it using options strategies. 
  • Learn why Larry says this is the golden age of options trading. 
  • Finish off the interview with a focus on automation, the future of trading, and where technology is going.

Larry's Background:

  • As a child, Larry was interested in stock and received it for his birthday.
  • He began trading in college and found his way into penny stock trading. 
  • It took seven years for Larry to build his trading up to a full-time business.

Buy the Fear, Sell the Greed:

  • In times of great deals of stress, the lower part of your brain kicks in and people become irrational.
  • The structure of your brain changes when fear comes into play.
  • Eventually, rational decision-making takes place in all walks of life.
  • Fear has been hard-wired into who we are; it's part of our DNA.
  • Logical thinking is replaced by overwhelming emotions, on both the retail and asset management level.

The Structure of VXX:

  • VXX was brought on in 2009 as a reaction to the market sell-off in 2008.
  • The VXX product was intended to protect traders and investors from market sell-offs.
  • When it first came out, it looked like it was a great idea, conceptually. 
  • Jump ahead a year, VXX lost 60-65%, after 3 years it had lost over 90%, and by 2013 it had lost over 99% of its value. 
  • This is just a reminder that it is a structural inefficiency combined with a behavioral inefficiency. 
  • Looking at the structure and chart, VXX was basically built to go to zero.

Two Structural Aspects with VXX:

1. Counting - need to sell the front-month futures options and buy the following month's. 

In most cases, over 80% of the time they are selling low and buying high.

2. Underlying Contract is a VXX Futures. 

The VXX is purchased as portfolio insurance (the main intent of creating the VXX).

Most insurance is overpriced, and VXX as a whole has historically been overpriced since it was created.

The Scaling Component

  • Mean reversion: nothing reverts back to the mean as well as the S&P.
  • When you get into volatility, it reverts to the mean even greater than SYP does. 
  • When using the scaling or laddering approach, it's essential if volatility is going to revert its mean, VXX drops in price.
  • As volatility goes up and VXX goes up, adjust your position size accordingly.

Case Study: VXX Options Strategy

  • The simplest way to construct an options strategy for VXX is deep in the money puts, 80 Delta or above. 
  • Structure the trade based upon how long you will be holding the position. 
  • The VXX market maker is willing to play and keeps an efficient market. 

Time Price and Scale (TPS) Strategy:

  • As ETF's become oversold, it is often for behavioral reasons. 
  • Fear can be induced in the marketplace by an event coming into place, or money managers pausing from buying. 
  • The 200-day moving average plays a big role; volatility substantially increases when markets and ETFs are below the 200-day moving average. 
  • The average gain per trade and the percent correct is greater when it's above the 200-day moving average. 
  • When you consider the day-to-day volatility of the movement it is like night and day.

Marko Kolanovic 

  • Marko is a chief strategist at JP Morgan, with a tremendous amount of input.
  • His team does high-level work on derivative markets and how it affects the overall markets. 
  • JP Morgan put out a report, which ended up going viral.

Automation and Computerized Trading

  • At the end of the day, if you are trading systematically that is in a sense computerized trading. 
  • You can place the set of roles into your execution platform and the trades get executed.
  • This rule-based and quantitative approach is trading systematically — automated. 

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Free Options Trading Courses:

  • Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
  • Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
  • Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
  • Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
  • Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
  • Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
  • Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
  • Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
  • Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.

Option Trader Q&A

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air.

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

PDF Guides & Checklists:

  • The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
  • Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
  • Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
  • Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
  • When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
  • 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.

Real-Money, LIVE Trading:

  • EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
  • VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
  • DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we'll discuss why I'm adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
  • COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
  • TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
  • MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
  • IBB Call Debit Spread (Opening Trade): We'll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
  • TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly - even still the drop in implied volatility helped generate a $330 profit for us.
  • XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
  • COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
  • EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
  • IBM Iron Condor (Earnings Trade): Shortly after the market opened you'll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
  • SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.

Thank You for Listening!

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.