12/7 Advanced Lab Notes

Discussion Notes
w/Tim Justice
12/7/09

Trade Reviews

~ David had an interesting question: do these strategies (short strangles and calendar) work as well in a bear market as they do in a bull market? The answer is yes and no. You can skew any trade to reflect direction. In crashing markets though direction and implied volatility are very unpredictable so these models may be harder to implement. If the market is just in a downtrend then yes they are just as good.

~ www.nber.org has data on recession and expansions. The average recession in the last 50 years is 10 months and the average expansion is 57 months.

~ If you've sold an option and the value of that option becomes worth very little (say a dime or two) then just buy it back and take profits.

Calendar Spread Targets

~ You must use a risk graph to complete the analysis described below.

~ When setting targets make a decision on what's reasonable. Once you do the analysis described below and put your order in settle on a number at a reasonable price.

~ When you enter a calendar spread it is wise to set a target. There are 3 factors that can affect the trade profits or losses: Time, Implied Volatility and Price.

~ Decide how long you want to stay in. First and foremost you do not want to hold this trade through earnings so you must get out before that event. If Earnings is far enough away you can use my defaults at 3-6 weeks. I start with 3 weeks on the risk graph and factor that in. If you choose to target up to 6 weeks go ahead and do so.

~ You must make an IV assumption. IV changing is a big part of this trade. Look at past earnings and IV cycles on an IV chart and make your best SWAG (Scientific Wild A$$ Guess). Don't ever assume greater than a 10% build (and this is just to make sure you're reasonable).

~ Once you've calculated (using a risk graph) time and IV changes and you decide on what is perfect ~ set a good-til-cancelled order for that trade.