The 17 Most Asked Questions by Option Alpha Members w/ Answers

This podcast is dedicated to the 17 most popular questions we are asked by Option Alpha members.
The 17 Most Asked Questions by Option Alpha Members w/ Answers
Kirk Du Plessis
Feb 13, 2019

We get a lot of emails each day - I'm talking hundreds of emails. Naturally, seeing so many questions and comments come through the system, we found that these 17 top questions keep coming up again and again. So, in an effort to help you, and our team reduce the support inquiries, I'm recording answers to each of these questions in today's show.

1. How do you determine which ticker symbols to trade? [See OAP 143: What’s The Rationale Behind Entering New Option Trades?]

  • Generally, You want to stay as mechanical as possible when it comes to choosing ticker symbols.
  • Trade many of the same tickers as a core portfolio.
  • Highly liquid ETFs and Index ETFs that you continue to trade on an on-going basis including, SPY, DIA, EWW, FXE, FXI, USO, and XOP.
  • Choosing the ticker symbols to trade starts with high IV,  high liquidity, and tickers that offer portfolio diversity.
  • Start by filtering for high IV, but also diversify the tickers that you are trading.
  • If you have to sacrifice some IV level for more diversity, that is okay.
  • Diversity Core: EEM, EFA, FXI, GDX, IYR, QQQ, SMH, TLT, XHB, XLB, XLE, and XLV.

2. When do you adjust, versus roll, versus close?

  • It is preferable to adjust a position in the current expiration month first - so always try to adjust first. 
  • If you can adjust a position in the current expiration month, that means you don't have to extend the trade to the next month or the month after.
  • Our research shows that holding a position a little bit longer towards expiration ends up working out better. 
  • So, even when positions get challenged early on, don't start making adjustments until you get into the month of expiration. 
  • If adjustments in the current month don't work, roll the position out to the next month for a credit.
  • If you can't roll the position out for a credit, then simply close the position. 
  • There's no point in taking a position that is going to be a loss and making it an even bigger loss by rolling it to the next month and paying a debit to do so. 
  • Instead, just take the loss, and reset the probabilities - which is where position size and diversity comes into play. 
  • Check out our series on Trade Adjustments/Hedges and OAP 087: The 3 Option Adjustment Principles You Must Know Now for more on adjusting positions.

3. Why do we enter trades with less than 70% probability of success? [See OAP 138: The “Expected Probability Paradox” For Options Traders]

  • Many times the initial probabilities that you see on brokerage platforms would suggest that we're entering the trade with less than 70% chance of success. 
  • The reality is, that is accurate for trade entry - based on how the probabilities are set up at trade entry. 
  • However, this does not account for things like IV's over expectation, early profit-taking, etc. 
  • So, when you actually look at what a win rate is on a trade after accounting for IV's over expectation, the trade might have an additional win rate of 7-8%.
  • This describes the expected probability paradox - the initial probabilities of success do not account for other factors that happen after trade entry.

4. Why do we trade tickers with low IV?

  • Even tickers with low IV still have a positive expected return when selling options.
  • In fact, our most profitable ticker over the last couple of years has been TLT, which has had some of the lowest IV.
  • This does not generally happen because high IV tends to pay more. But when you are trading low IV, you can still generate positive expected returns.
  • The problem that most people have when trading low IV tickers is that they tend to over-allocate during those situations.
  • When there is low IV, you should scale back your position sizing.
  • Another reason to trade low IV tickers is for portfolio diversification purposes.
  • There's no point in trading all high IV tickers if all the tickers are in one sector or industry.
  • Instead, trade a low IV ticker to protect your portfolio and give yourself diversity.

5. How much money do I need to generate X amount of income? 

  • On the very low end, you should be able to make 4% withdraws from your account without depleting or significantly hurting your account moving forward in the future.
  • Take the amount you need to generate at the end of the year, divide it by 5% or 10% (your withdraws), and that's how much you will need.
  • This does not include fluctuations, variants, or portfolio volatility.
  • You could easily go through a period of 3-6 years of sub-par or average returns.
  • That doesn't mean that the system is broken and that it won't make money; it's just how the sequence of returns is starting to develop. 
  • If you are taking 10% out of your account for the next 5 years and you go through a random sequence of flat returns, you could really set yourself back. 

6. How do you keep up with adjustments and rolling? 

  • I use a pad and paper on my desk.
  • When you have a position you adjust, take the original credit and add the existing credit.
  • Keep track of each adjustment or roll by writing it down. 
  • Take your time, and keep track of all your debits and credits.

7. Why can't I find perfect pricing? [See OAP 138: The “Expected Probability Paradox” For Options Traders]

  • Getting perfect pricing on trades is no longer the requirement. 
  • Research and backtesting shows that when you get less than perfect pricing, you are still compensated because of other factors like the ability to close early, the ability to roll contracts and adjust, and IV's over expectation. 
  • These factors allow you to get less than perfect pricing on trade entry and still generate a positive expected return.
  • Although perfect pricing is the goal, you don't want to inhibit yourself from trading by skipping out on trades that don't have perfect pricing.

8. Is there any formula for laddering into trades?

  • No, there is no perfect formula for this. 
  • Backtesting research shows weekly trades performed better than sequential (one-by-one). 
  • Generally, breaking your trades into at least a weekly entry did better than sequential trading. 
  • Beyond that, daily performance across the board was better than weekly performance.
  • On average, you want to be entering at least a trade or so per day.
  • That does not mean it has to be in the same ticker symbol; you can spread it out.
  • Enter a new laddered position when the existing position moves from your center point.
  • We do a lot of neutral trading. If you enter an iron butterfly at $50 when the stock is trading at $50 and the stock never moves outside of $50, don't enter a new position. 
  • If the stock moves up to 53 or 54, at that point, you can enter the next set of laddered entries. 
  • Therefore, simply wait for the stock to start moving before entering a new set of laddered entries. 

9. What do you do if you are assigned?

  • Assignment is part of the trading business and is bound to happen. Check out our Answer Vault: Assignment and Expiration for answers to frequently asked questions on this topic.
  • For the most part, assignment is random, and you don't know when it will happen. 
  • However, we do know that assignments frequently come towards the end of the expiration cycle. 
  • The first question to ask when you get assigned is, "What can your portfolio handle?"
  • If you have a portfolio that can't handle the assignment, then the immediate answer is to close the assignment.
  • This might not be an ideal time to close, but it's better than taking on too much risk for your portfolio.
  • If your portfolio does have the capacity to handle the position, then the next question is, "Where is the stock?"
  • Next, look at the technicals: do they suggest you're at the bottom end of the range, or, potentially, towards the top?
  • If you are toward the top and you just got assigned shares and technicals are flashing sell signals, sell your stock.
  • Definitely lean on the technicals to determine whether to hold on to an assignment or to dump it. 
  • From there, if you decide to hold the position, the next question is, "Can you sell any options against this?"
  • In almost every case you should be able to sell options against the assignment. 
  • This helps to reduce or increase cost basis, which helps to bring you back to a win or reduced loss on the position. 

10. What is portfolio balance, and how do you determine it?

  • The best way to determine your portfolio balance is to Beta-weight your portfolio. See our tutorial: Balancing Your Portfolio with Beta
  • Just looking at the raw Deltas does not help, completely.
  • You have to look at the Beta-weighted portfolio curve of all of your positions.
  • The reason you want to use Beta-weighting is because bonds and stocks are going to move differently compared to bonds and oil, or real estate, etc. 
  • All of these things have different Beta equivalents to the market, and they will behave potentially differently.
  • You want to make sure that you are getting one true look at the portfolio compared to a Beta-weighted index.
  • From there, look for a symmetrical payoff diagram with the index you are Beta-weighting in the middle. 

11. Why not just trade one ticker that backtested well?

  • The tradeoff you have when trading only one ticker is that you are highly susceptible to the variants and volatility of that particular ticker symbol.
  • If that ticker symbol goes through a random black swan event that has a drawdown of 30%, that means your portfolio immediately goes through a drawdown of 30%. 
  • Instead, trade a little bit more complex portfolio construction for the ability to neutralize the variants in your account. 
  • Instead of having one ticker symbol that trades really well, trade a couple and deal with the complexity of having multiple positions in your account in exchange for having less volatility.
  • [Check out OAP 157: The Untold Story Of The 3 Little Pigs That Traded Options for more on the impact of drawdowns.]

12. Should I day trade or swing trade with options?

  • For sure, not day trade. 
  • Day trading is highly susceptible to losing streaks and drawdowns.
  • Position or swing trading options is more of what we do. Swing trading is essentially taking on positions for 30-40 day time period. 
  • We swing trade options by trading positions that are generally neutral and maintaining balance in our portfolio. 

13. How can you get a higher trading approval level? [See OAP 048: Options Approval Levels Tips – How to Quickly Work Your Way Up The 4 Different Levels]

  • Generally, you have to work up the approval process.
  • You can get a high trading approval level right out of the gate, just make sure to check the right boxes when you do your brokerage application - growth, speculation, experience.
  • That said, you can quickly move up the different levels. 
  • The reason that brokers have these levels is that they want to make sure people are aware of and understand the risks of trading more complex options strategies. 
  • You can show proof that you won't blow up your account and understand the risk to get a higher level.
  • However, if you can't get a higher level at one broker, move to another broker.

14. Why don't we trade more weekly options strategies?

  • Weekly options strategies backtested really well in our profit matrix research.
  • The reason we don't trade them as often, now, is that we plan to do them once the auto-trading platform is launched. 
  • Weekly options require a lot of management, but allow you to reduce a bit of the variance in your account.
  • Monthly trades make the same or more than weekly strategies, and require a lot less activity and churn for commissions.

15. Why don't we place many earnings trades anymore?

  • We haven't been placing a lot of earnings trades, because we've been finishing up a lot of research on earnings. 
  • We've done a lot of research on earnings strategies, we backtested all types of tickers, sectors, and industries.
  • The data on earnings have now been compiled, and we are now combing through it.
  • Until we finish up the analysis, earnings trades are on pause for the time being.
  • [See OAP 174: We Stopped Trading Earnings After We Saw This New Research for the results.]

16. Why do we trade so many iron butterflies?

  • The main reason is that they backtest really well as straddle synthetics. They are straddles at their core.
  • When you look at the profit matrix, the strategies that do the best overall are straddles and short strangle synthetics. 
  • Straddles are highly capital intensive requiring a lot of margin.
  • Conceptually, they represent neutral, pure options selling, are easy to adjust, have fast time decay, and have fast opportunities for profit-taking. 
  • Trading iron butterflies allow us to trade straddle synthetics.
  • Essentially, we are trading straddles and choosing to buy insanely cheap protection on the wings to help reduce margin exposure, keep ourselves in a risk-defined format, and reduce volatility in our account.

17. When's the new platform rolling out?

  • We have new updates that we are pushing to the platform on the backend every single day. 
  • We hope to have something out in V1 here in the next couple of months. 
  • The platform will be rolled out in various versions, going through this agile framework.
  • All updates and sneak peeks are on videos inside of Facebook.
  • Adjustments and iterations to the platform will be made immediately from V1 feedback.
  • For more information, check out Option Alpha’s New Auto-Trading Platform Updates.
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