Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to talk about how to profit from the emotions of other traders and investors. Someone recently asked again in our Facebook community and they said, "Kirk. How do you determine a psychological factor when considering options or do you consider any psychological implications upon noticing volatility in a certain stock or a movement in a certain stock? Are you just focused on the numbers or do you see value in the emotions of others in the market?" I thought it was an interesting insight. "Do you see value? Can we make a trade based on the emotions of other people and how do we discern the emotions of other traders in the market?" I think this is actually a very easy answer and the easy answer to this is that as options traders, we are always making trades based on the emotions of the underlying market or the mass or the herd and many people have said this. I don't know who was originally credited with it, but it's this idea that people think logically, but they act emotionally and it's no different in the options market. Believe me, having been in this for 10 years and even just seeing a lot of traders come through Option Alpha, we always get people who think logically and they understand the numbers of how options trading should work and how a high probability system should generate money over the long run, but for whatever reason, they are attached to one single trade that ends up being a loser in their first three months or their first two months and they know rationally that it's totally part of the business and part of the process, but for some reason, they just act crazy and overly-emotional because they're tied to it and so, they think logically, but they act emotionally.

This same thought process could be held in the regular markets when it comes to option buying and option premium. Because we know that implied volatility is always overstated, that means that on both sides of the market, long-term investors are always over-reactionary and overemotional in both directions. Call option buyers are euphoric and think that everything is going to go to the moon and so, they overpay for call option contracts relative to what actually might happen in the underlying security. Put option buyers get overly-fearful and really worry about black swan events and they over-purchase protection to the downside and that's relative to what actually happens in the underlying stock. I guess you could say as an options trader and specifically, as a premium seller, we're always trying to take advantage of the over-reactionary or extreme emotions on both ends. I think when it comes to the underlying stock, I think we always see an overreaction at some point. We recently saw it at the top in 2018 which we said was going to happen and we played that perfectly. We said that during the bottom and the early part of 2019, we're now seeing it in a little bit of a topping process here kind of like February, March of 2019 where the market has rallied so far, so fast, it's gone almost parabolic, nobody is fearful anymore and two and a half months ago, everyone was fearful. We see these large swings in emotions and I think as an options traders, what you have to do is you have to kind of drown most of that stuff out because you know markets are cyclical, they don't move in one direction and we want to take advantage of the broad underlying edge that we have in implied volatility. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "How do you adjust position sizing when rolling option trades?" I think this is a really great question and this came out of our Facebook community where somebody posted in there and they said, "Kirk, for your small position sizes of 5% or less, how do you account for the positions that moved against you and you're rolling forward a credit month after month?" For example, they said, "If your 2% position in TLT for January expiration needs to be rolled to February, what if you already have a 2% position in TLT in February at a very different strike price due to a sharp move up or down in the underlying security and now, you're basically forced to carry this blended position in February of 4%? So, 2% from January that you rolled to February and 2% that was already there kind of existing in place. And so, what if you then needed to roll both the positions forward to March due to some bad sequence of returns or trades? Can you now basically not take on any new bond positions because you're already at 4% exposure in TLT and that's already at the higher end of our threshold?"

I think this is a really insightful question, something that we haven't really covered before which is why I want to cover it on today's daily call podcast. I think the answer to their question is yes, you should probably stop adding positions once you reach that 5%-ish threshold that we talk about all the time. The reason that position sizing is so important is because it allows you and it's basically the checking balance that allows you to control risk based on how much of a position size you're building in any contract month. And so, by holding to that position size in a very firm way, meaning not breaking those rules under any circumstance is really your backstop and protection for major black swan events or bad sequence of returns. In this case, this is exactly how I would do it had I been trading through this scenario. If I build out a portfolio, I usually split out my allocation across two different expiration months, I would do 2% or 1% in one month and two or 1% in the next month and that allows enough room for me to roll to the next contract month and maybe even still then continue to add positions in the next month. But if you're trading a smaller account or if you just have over-allocated to this originally in the first two expiration months, yeah, you definitely want to reduce your allocation or keep your allocation at the 4% level and not add any more positions moving forward.

Now, an interesting thing to note is that if you start moving the position from say February where you have 4% allocation in TLT and you move that to March, well, now, all you've done is just roll it for a duration and extended the timeline of the trade and that's not necessarily a bad thing. That's very much the same thing as if you were to close out February and reopen a new position in March. Many people consider that to be the exact same position as just rolling the trade from February to March for a credit and I would say the same thing. I don't think it's a bad thing to actually keep rolling it forward. Even if you have to stay at the 4% level, it still makes sense to do it and you still get a credit for rolling into the next expiration period and extending duration, why not? Why not give yourself an opportunity to extend the trade and if the trade turns around and becomes a loser, at least by taking in a credit, you've reduced risk along the way. In fact, we've actually done this exact same process before in TLT and EWZ and GLD where we've had to roll and extend trades two, three, four, sometimes five months out into the future and that means that during those periods, we weren't adding to our position, we were just basically taking the same position and moving it from month to month to month because we could roll for a duration and credit. Hopefully this helps out. If you have any questions, as always, let us know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "How long should you hold stock after put option assignment?" This question comes in from our community and somebody asked – "When you're put a stock, how long do you hold onto it and write calls against it? It seems that keeping the stock and writing calls against it is seriously reducing your return on capital compared to just eating the loss and selling more iron butterflies or iron condors." I think this answer is a two-part answer. The first part of this answer really comes in the form of asking yourself a question which is – "Do you have enough capital to hold the stock after assignment?" Many times, if we're selling say a spread or a single short put option, we want to make sure that we have enough capital on our account to hold the stock should we be assigned. Now, this isn't necessarily a requirement because you can easily reverse the trade with your broker even if you don't have the capital to hold the stock. The brokers realize this and they know that you can get out of the position which is why they allow you to reverse the stock the day that you're assigned. But if you want to hold the stock, the first question is – "Do you have enough capital to hold it?" If you cross that threshold and you say, "Yes, I have enough capital to hold the stock." Now, the question becomes – "Do you want to hold the stock?" And I think the drawbacks to holding stock are exactly what this person got at which is really just reduction and return on capital. As we all know, stock position and equity positions are very inefficient compared to an option contract.

Now, this doesn't mean that we shouldn't hold stock positions and we couldn't hold stock positions for a couple of months, but generally, we don't want to be in the business of holding long or short stock on an ongoing basis. My thought process after being assigned any contract is to just honestly look at the technicals and use the technicals as the foundation for determining if I want to hold onto the position for the next month or so. Oftentimes, if we get assigned on say a put option contract, I'll look at the technicals and if the technical signals we're using suggest the stock might go higher or could be in a bottoming process, I'm a little bit more willing to hold long stock for the next two months and sell covered calls against it. In fact, we've recently done this on a handful of securities that we've gone over in our weekly podcast where we talked about the assignments that we've had in GLD, TLT, EWZ, etcetera. You can check those out on the weekly podcast. All of those positions, we were assigned. We looked at the technicals. The technicals suggested that we hold the stock and so, we did and we sold covered calls against it and waited for a little bit of a rebound. Now, if we had looked at the stock technicals and we saw that maybe the stock at the time we had been assigned on our put option contract and our long shares actually was suggesting that the stock was going to roll over, then in that case, I might be more willing just to eat the loss or dump the position and move onto another contract strategy or another expiration month. Again, I think it is really a judgment call. For me, most of the decision on how long we hold it and how much of the assignment we hold comes back down to the technicals and then from there, we'll definitely use covered call or covered put strategies to reduce or increase cost basis depending on which direction we were assigned. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Can you close a covered call before expiration?" This question again, comes out of our Facebook community. Somebody sent me a message and they said, "Kirk. Can you manage a covered call if the stock rallies up to your short strike before expiration?" Assuming you want to keep the stock, of course, maybe you roll your call to the next month. Again, I think the key part here is that they want to assume that they for some reason, want to keep the stock and do not want the stock to be called away, so if you have a covered call position on and the stock rallies past your short call strike, at the end of expiration if you don't do anything, basically, what will happen is you'll get assigned on your short call option, but since you have the underlying shares of stock in your account which creates the covered position, basically, it's a loss. You just close out of the position at whatever the net price is for the covered call.

If you don't want to have that happen and if you want to maintain it, then yes, you can close out of and reverse your short call option position and roll it to the next month. Now, just be careful when you roll these positions to the next month, that you don't just roll to another in the money strike in the next month because if you roll it to another in the money strike in the next contract month, you still could be at risk of assignment. Say if there's a dividend coming up or something's happening in the stock or earnings are going to be announced, you still could be at a little bit of a risk of assignment even though you've rolled the contract out to the next expiration period. Now, likewise, you can also close your covered call if the stock moves away from you. If the stock starts to fall away and you want to actually close your short call option and roll down to a closer strike price to take in some more premium, you can do that as well. Remember, all of these option contract unless they're on a European style index like SPX, NDX, RUT, etcetera, you can close out of these positions and move the contracts anytime and you don't ever have to deal with any of the risk of assignment if you remove the option position. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to talk about iron butterfly management, close in full or just the inside legs. Many of you guys who follow us and follow the trades that I do… I do a lot of iron butterflies. I love doing them. We talked about them in detail about why we like them as straddle synthetics basically and then the ability to buy the outside legs for risk protection and margin protection for our account. And now, the question becomes – "When we get into a position that ends up hitting a profit target, what do we do? Do we close the full position or do we close just the inside legs?" Many people who are pro and elite members and follow the trades that I do, I will do both of these and it really just depends on the situation. And we're going to talk about that here in a second. But I will sometimes close the entire position in full. Sometimes I will close just the inside legs and I kind of flip back and forth between doing this. Now, it's not that I just flip a coin and I say, "Okay. This time, I'm going to close the position in full and this time, I'm going to close the inside legs." There's actually a logical process to how we do it and there's a reason why we would choose one over the other.

When it comes to closing an iron butterfly, what I look at specifically is the value of the outside legs or the outside wings. That alone will determine whether I choose to close the position in full or just close the inside legs. For example, if we are trading an iron butterfly and we sell it for let's say $100 and now, the iron butterfly in total, is worth say $50. Maybe it reached a 50% profit target for us and we're going to look to close the position. Well, if I look at the value of the outside wings of that iron butterfly and I see that those outside wings are not worth anything, maybe they're worth a penny and it's just a placeholder there until expiration, well, then I know that all of the value of that $50 is tied up on the inside legs. And so, by closing the outside wings if I were to get filled on the position which is still a big if, I'm not gaining much from that. I maybe take in $1 of credit for selling back those outside wings and then after commissions, maybe I'm only left with a little bit of money, a couple of quarters or if you trade on Robinhood or some of these free brokers, you only get $1 for doing it. It's not really worth it and you still got to fill those positions.

If they're worth $1, they're worth $2, in many cases, I'll leave them on, let them expire worthless and I'll just simply close the inside strikes because most of the value or all the value is tied up on the inside strikes. There's no reason to force ourselves to fill these illiquid outside options that are not worth anything anyway. What I'll do is I'll leave these on and I generally call them our little lottery tickets. If the market does blow up or if aliens invade earth, then these things will go bananas and will pay out huge. That generally does not happen. I've only ever I think maybe closed a couple these once or twice or maybe even less than a handful of times before in the past and it has not been major outsized gains. Sometimes they go up $50 and you can close them out for an extra little profit, but it really doesn't happen that often. We just leave them on because they're not hurting our portfolio. They're helping reduce black swan risk if you can consider it that way, but it's just not worth it to close them.

When I look at those outside wings and if I see that those outside wings have a lot of value left in them, say over $5, they're worth $10 or $20 or in some cases, still worth $40, $50 or have moved a lot, then I will definitely close the entire position because I know that if I can close all the wings and all the strikes together, I'm still left with a $50 kind of value and that's at my profit target after I closed everything, then I'll do everything in full. Again, to me, the biggest determinant for making this decision is the value of the outside wings of this iron butterfly. If the value of the outside wings is a couple of pennies, I'll probably just close the inside strikes, leave the outside wings on to expire worthless. Hopefully this helps out. If you have any questions, let me know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "How much money do you need to short or sell stock?" This is a big question that people ask all the time and it's particularly interesting when people start getting into the world of investing and trading. They learn that they can actually make money by shorting stock or selling short stock and they can make money after the stock drops in price. You don't have to make money necessarily by buying stock and then selling it at a higher price. You can sell it or short-sell it and then buy it back in at a lower price. Now, the question is – "Well, how much money do I need to start doing this?" Well, there's a couple of things you have to think about. One, you have to think about the initial margin that's required on a position and many brokers then kind of hamburger on or stack on top of that, their own individual brokerage requirements.

Right now, FINRA who's the regulatory agency for this requires that you at least have $2,000 in your account if you're going to go on margin to do this which is what you would essentially be doing when you go short stock and many brokers like Charles Schwab or Fidelity or TD Ameritrade require that you have something more than that in your account before you start selling stocks. There's the standard for FINRA and the regulatory side and then the brokers will also later on top of that, their own requirements for what you have to do to sell short stock. Besides this, FINRA also requires a maintenance margin which is 25% of the value of the shorted stock in your account. This is important because they want to make sure that you have enough money to cover any potential losses should the stock actually increase in price. If you short stock at say $20 a share and it goes up to $30 a share, you're going to have to come up with more cash or just have enough cash there as a cushion to allow for the 25% of that new stock price in the future. Some brokers are even as high as 40% or 50% in maintenance margin.

Again, FINRA is just kind of setting the bar here of 25%, but then most brokers will have some sort of layered protection on top of that based on their own risk parameters and how risky they perceive your account or people with your types of accounts being when you short stock. Ultimately though, as an options trader, I don't think you ever need to short stock. You can go short a security and bet against that security if you want to do that with options and you can do it in a much more risk defined capital efficient manner with a much higher probability of success. I think shorting stock is great and is fine. I think it's a good thing for the industry. I just don't think that people need to do it on the retail level, the personal level like me and you when we're actually trading. I think it's just way too much risk for individual traders to be shorting stock. I don't think you need to do it. I think you can use options as a means to bet against the security or bet against the stock going down and it's much more controlled, much more capital efficient. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "How reliable are option probabilities when markets are volatile?" I want to tackle this question by using an analogy and just kind of telling a quick story here with my son. My son who's our third child is about nine months old now. He started to crawl just recently. Now, he's starting to kind of lift himself up on things. He thinks he's really cool and he can lift himself up on chairs and desks and walls and so, now, he's starting to progress into this different stage of going from crawling to eventually walking. But just the other day, he was lifting himself up and then tripped himself basically because he was trying to figure out how his feet works and he tripped and fell and kind of hit his head pretty hard on the floor as he was trying to lift himself up. And so, in this moment now, this has now changed how I view him and how I'm parenting him in the sense that I'm much more protective and I'm right there next to him with my hands on both sides when he starts to lift himself up because now, I know he's got enough strength to do it and he could potentially fall again and kind of trip himself and roll and hit his head and so, now, I'm overprotective. Now, any little sudden movements even if potentially, that's not going to lead to him falling down and hurting his head ends up being something that I catch him on or I hold him up or I tilt him back in the right direction, kind of like lean him in the right direction. And the reason I use this analogy is because conceptually, the same thing happens if you think about it in the options market when we go from periods of low implied volatility or low volatility to periods of high volatility.

When markets are calm and there's no volatility, option pricing I would say as a whole starts to contract. People are not as afraid. They're not as worried because they just don't know what's coming. They don't know that something is going to happen, some black swan event is coming down the line. And so, generally, during low implied volatility markets, we see this contraction in option pricing and option probabilities and now, the probabilities start to more mirror what the expected outcome is in the market. Now, this is not to say that option probabilities end up being exactly what the expected move is. We still see over-expectation in option probabilities. Let's say the market is expecting a stock to move 10%. The stock might move 8%. There's still an over-expectation, but it's becoming smaller and smaller. That margin or that spread is starting to contract. When we start to see now a black swan type of event, say my son falling and I didn't know that he had enough strength to get himself up and then trip himself, now, this black swan event totally changes the market and so, now, option probabilities and option pricing swell and people start buying options aggressively and there's much more volatility and there's much more movement in the underlying stock and what happens is that the market overreacts by a much larger margin. Now, volatility might be expected on a stock of say 20%, but the option pricing is assuming the stock is going to move 30%. Yes, the markets are volatile, but what we end up seeing in these volatile markets is that option pricing is over-reactionary to what actually ends up happening. This is why during these time periods, you end up generally making the most amount of money trading options on a kind of per trade P&L basis because the markets overreact. Just like me as a parent when my son fell for the first time just the other day, kind of standing himself up, now, I'm over-reactionary and I'm right there with him no matter what happens and in many cases, he hasn't fallen a lot. He kind of trips and stumbles, but he's kind of getting his balance and so, that's what ends up happening in the market too. Markets overreact, option pricing swells, we get a much wider margin or disparity between the implied expectation and the actual reality of the stock.

Hopefully this helps out and hopefully this answers the question. If you have any comments or have any other questions you want to get added to the show, please head on over to optionalpha.com/ask and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we got an interesting topic and we're talking about using other people's money (OPM) for investing in options. Somebody recently wrote in the Facebook group and they said, "Using other people's money or bank loans for investing is common in startups and real estate. (which it is) Is there any particular reason why this shouldn't work for options considering that we're only investing in this vehicle out of the three mentioned here (we can invest in options, startups or real estate) that can set realistic probabilities of success? Why risk yourself getting a mortgage, buy a house and try to rent it to cover the mortgage payments and other expenses and not getting a loan with the lowest possibly APR to increase your capital to invest in options?" Now, look. I will definitely blanket say this statement that I do not agree necessarily with this style of investing. One, because I feel like as opposed to other things like startups or real estate which in some cases, you have a little bit more control over which is different than options trading, that when you get into the world of options trading, what is your single biggest risk in this environment (and we have talked about this on weekly podcasts) is the idea of this sequencing risk that comes with a high probability system like this. Just using real estate because I also invest in real estate, so I can speak to this on very high level terms, when you invest in real estate, you have a lot more control over what you're going to do, so there's no blanket like you're going to rent it or you may not for eight months because you could reduce the rent and potentially rent it out for less than expected, but at least you're going to keep it rented for eight months. Maybe you shoot for $1,000 in rent and you can't get anybody for a month, so you drop it down to $900 and boom, you've got a tenant.

There's a lot more control over what you can do there. In the options market, though you have control over position size and all these things that we talk about, tickers, diversity, portfolio balance, what you still don't have control over are things like black swans and sequencing risk. Even the best portfolio, the best position size, everything can go through just a bad sequence of returns where you just have a pretty good drawdown that you have to ride out. And so, the question becomes – "If you go through that type of scenario and you're using OPM or other people's money, how long can you survive in that void or that gap before you start having to miss payments or leverage other things to make ends meet? And so, I'm not a fan of it for that reason. Sure there's probably exceptions to the rule. There's probably people who like if you can get a 1% 30-year loan and it's interest only payments, okay, maybe, I don't know. You could probably build a case for me and sway my decision. Generally though, I don't think it's a good idea only because of the sequencing risk that's involved in markets and I think people end up doing things that are not necessarily the best for their portfolio, is trying to fight back and especially when you have loans hanging over you or payments hanging over you, you tend not to make the best decisions. Anyways, that's my take on it, but as always, really good interesting topic to discuss. If you have any questions, let me know and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, our question is – "Should you take profits early when selling naked puts?" Again, this question came out of an email that somebody sent me and they said, "Kirk. When we're selling puts on a quality stock, is it more advantageous to go ahead and take the 50% profit like we would on a spread or should we let it go to expiration for the full credit being that the worst-case scenario is you put the stock and you wouldn't mind owning it anyway? The idea is that to turn right around and sell covered calls on it should we get assigned." We're basically talking about a concept called "the wheel strategy" which is you sell a put, if you get assigned, you end up doing the covered call and then you go back and forth through this cycle or this wheel of selling puts and selling covered calls, etcetera.

The sticking point on this question I think that's really interesting is what they said when they set a quality stock or basically a stock that they wouldn't mind owning. The question is always and I post this to people a lot when we're doing coaching is – "Do you want to own the stock or are you more interested in generating income from selling options against it?" And then if you want to own the stock, then I would say go ahead and ride it out for the full credit because what is ultimately going to happen at some point is you're going to end up owning the stock. It's not a matter of – If it's going to happen, but when it's actually going to happen. But if you're more concerned with potentially generating income and making money from trading options around a stock, then I would say you're better off to take profits.

Now, again, the tradeoff here is that when we do back-testing and research, we know taking profits early helps improve win rates, reduce drawdowns. All that stuff is good. But what we do know from research too is that when you hold it a little bit longer towards expiration and in some cases, not all the way to expiration, but maybe hold it for a 75% profit versus a 50% profit target, you end up generating more money overall, but in exchange for that additional benefit of generating more money, you also have a little bit more volatility in your account which means that you might potentially have slightly lower win rates in some case, you might have bigger drawdowns in some cases on the way to generating more money. It is a tradeoff. It's not that you can just arbitrarily do one versus the other and it ultimately ends up being the same result. You are going to have a little bit of a tradeoff from generating more money to maybe a little bit more volatility in your account.

Hopefully this helps out. As always, if you have any of these scenario type questions you want to shoot over to us, head on over to optionalpha.com/ask and click the big red button in the middle of the screen. That's where we get a lot of these for the daily calls and also for the live Q&As that we do and until next time, happy trading.

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're answering a question which is – "Does low IV mean that we should be less active selling options?" When we're talking about IV, we're talking about implied volatility. This can either be implied volatility rank or implied volatility percentile for an underlying security that you're looking at. But the question again is – "Should we be less active when selling options during low implied volatility environments?" And I think the answer to this question is yes, we should absolutely be less active overall. Now, that does not mean that we are not active in selling options. We still need to be selling options, but what we should be doing is we should be scaling back our position size and waiting for higher implied volatility markets to be a little bit more aggressive.

Again, this doesn't mean that we should not be option-selling and perform option-selling strategies like straddles and strangles, iron butterflies and iron condors. You should absolutely still be active in selling options, but we should just be less active than we would otherwise be in a high implied volatility market. And the reason that we want to do that is because we know during high implied volatility setups, we generally see better win rates, we see better total P&Ls, we see less volatility in the portfolio generally, so that means during low implied volatility markets when we're still going to have an opportunity to make money selling options, we just want to scale back our position size and not be succumb to basically plowing a bunch of capital into a non-perfect environment or a non-close to as perfect environment as we could possibly get to. When implied volatility rises and we start to see a lot more volatility in the market, then was start scaling our position size up a little bit to take advantage of that. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.