Once you have identified a possible trade and a strategy that you want to use, we will help you set up your trade tab so that you can correctly analyze volume, open interest, and deltas for probability analysis.
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In this video, I want to show you how to correctly set up your trade tab when you actually decide on a stock and a strategy that you want to use.
You want to make sure that you guys are setting up these trade tabs correctly, so that you can appropriately find and price the right strike prices for your strategy.
What we have here right now is XLF, and we just picked a stock that we wanted to look at. But the stock is trading at about 24.21 right now, and we’re just looking at the February expiration options.
This is just giving us a frame of reference to use. In most cases, most broker platforms when you actually log in are going to show you always bid ask spreads.
That’s always going to be a definite, you will always have these two columns for bid ask spread on both sides for calls and puts, but in most cases, they’re going to show you Delta, Gamma, Theta, Vega which are the option Greeks. I honestly have no idea why they show you this.
In fact, it’s completely ridiculous that they show all four of these at the same time because it doesn't give you any clear-cut information on probabilities and volume and liquidity. It gives you nothing.
What we’re going to do is we’re going to change things up here a little bit, and we’re going to create a custom layout by adding some different columns to our trade tab. What I’ve already done is I’ve already saved this in my platform as my Option Alpha setting, and that's what I use here.
As a reminder, if you need help setting up your trading platform, we do offer a service where we will help you to setup your trading platform.
You can find out more about that by just going to the dashboard and clicking on platform setup, and we'll do all of this for you on the backend if you don't want to mess with it and go through all of these tutorials with us.
But if I click Option Alpha, it gives me a whole new setting for the trade tab, and this is what I want to go over with you guys tonight. As always, the bid and the ask always stay the same.
We are going to leave Delta, but only for the purposes of this video because I want to reference back to one of the previously videos we did in that Delta is a good way to use and calculate probability of being in the money if you don't have a probability calculator on your broker platform or if your broker doesn’t offer it.
For the purposes of this video, we’ll just use Delta again as a conduit for calculating the probability of being in the money if your broker doesn't provide that type of data. The first thing that we have on the columns is Mark, and I think Mark is really important.
On Thinkorswim, it sets up on the left-hand side of the columns. But Mark is really important because it shows you what the last trade was in between the bid and the ask spread and it gives you an idea of where the market is trading or what price traders are coming to an agreement on.
In this case, you can see the 22 strike puts for XLF have a bid ask spread of 14 and 17, but that doesn't mean that the options are trading at 17 or 14 and in fact, the last trade was done at 15.5. This gives you a good frame of reference.
And when you're trading higher valued options, sometimes the bid ask spread can be $40 or $50 wide. And knowing the exact price that the options are trading at is very important because that minimizes the slippage that you have in some of these trades.
Can you imagine if you’re trading a $40 or $50 wide market, and you enter the wrong order, maybe $10 or $20 above or below where the market is trading, you might get filled automatically, but you didn't get filled at great pricing, and in fact, you probably got filled at really bad pricing if you get filled instantly.
You want to weigh it a little bit, and Mark helps you do that by knowing where the options are trading. The next two columns that we have are volume and open interest. Both of these are important because volume is going to show you the actual activity for the day and then open interest is going to show you what contracts are remaining open.
I consider volume to be the indicator as to how active the markets are during the day. If we see a lot of contracts traded in a set range of strikes, we know that those strikes are going to be pretty active.
In XLF, we know that pretty much all of the strikes between 20 and about 27 are pretty active on the put side and likewise, we have a great open interest in that market as well.
Open interest for me acts as a depth indicator, so how deep are the markets, how many people have traded it before, have positions in it right now, how deep are those markets, so that maybe if those people who are trading at today don't show up tomorrow, is there going to be enough traders in the market for me to get in and out of a security.
And having this on a chart narrows down the window of options that we’re going to trade. We don't want to trade pretty much anything below the 20 strike on the put side and on the call side, there’s a pretty hard line right here at about the 26 strike.
Even though Thinkorswim presents all of these options beyond this point, the 27s all the way up to the 36s, there’s practically no market for those and there’s very, very low liquidity in those markets which means it’s going to be incredibly hard to get into and out of.
But you wouldn’t have known that had you not added volume and open interest to your trade tab.
The last two columns like I had mentioned earlier is the probability of being ITM or in the money and then Delta which is that conduit for calculating that if you don't have it on your platform.
Probability of being in the money calculates the likelihood of the stock moving from where it is currently right now wherever it’s the last trading up to and beyond your strike price of that particular level.
In this case, the 26 calls on XLF, XLF has about a 10% chance of moving from 24.21 where it’s trading right now up to and above 26 between now and expiration which is 46 days away.
That probability factor helps us with creating high probability trades that allow us to take in a lot of premium and extend our trading timeline out into the future. As always, I hope you guys enjoy these videos.
If you have any comments or questions, please add them right below in the comment section and until next time, happy trading!