Hey everyone. This is Kirk here again from Option Alpha. Welcome back to the daily call. Today, we're going to answer the question, "What is the difference between speculating and hedging?" I often hear the terms, speculating and hedging thrown about in forums and in emails and people assume that both of these things are the same. And while they might perform potentially the same types of trades, the psychology of the investor going into a speculation trade versus a hedge trade could be completely different. For me, speculating is the assumption that you're getting into a trade with huge potential risk reward payoffs. And so, this speculation is built up by the trade that you're getting into in the sense that you're building an option strategy or a stock strategy or a combined option stock strategy with the purpose of generating positive expected returns. Now, you assume that this is going to happen and that's the part of the speculating. You're speculating that this is going to happen though you don't know for sure. But the assumption with the speculator is that they're generating money with their trades. All of their trades are focused or at least, the trades that they're speculating on are focused towards generating a positive expected outcome, generating Alpha or superior returns with their trades.

If you take the other side of the coin, a hedge trade would be a trade that is looked to minimize the risk or reduce the risk of other trades in the portfolio. The reason that we call hedge funds, hedge funds is because they have the ability to trade both sides of the markets versus say a regular mutual fund which only has the ability to basically buy. And so, hedge funds were created basically, so that there was an opportunity or an alternative where you could actually use a long position in the market, but then use a long put option contract to hedge that position in the market or you could short some sectors or industries of the market to hedge your long position in the market. Hedge trading to me could perform the same thing. You could actually be buying the same contracts as a speculator or hedger, but again, the underlying assumption is with someone who's hedging a position, they might understand that that hedge trade is solely for the purposes of protecting themselves in case the worst happens. And so, for that reason, they might already assume going into the contract that they plan on losing that money, but they're okay losing that money because of the amount of risk reduction that they received during the contract time period.

To use an analogy with insurance, if you have a house that you own and you buy insurance in case it burns down, the premium that you pay to the insurance company, you're basically planning to lose. You are hoping that your house does not burn down to the ground. You don't ever want to make a claim that your house has burned down to the ground. You'd be happy at the end of the year paying that premium to the insurance company in exchange for the reduction in risk should your house burn to the ground and that's the same thing that hedgers do. Hedgers will pay a premium. That doesn't necessarily mean that they think or that they speculate that the market will go down or a stock will go down, but they're basically covering themselves by using a hedge technique, whether it's long put options, whether it's call options, a combination of options, but that's what they're doing. Again, speculators are really looking for these options to create potentially an asymmetrical risk reward scenario with a low probability of success. Hedgers are taking the other side of it and looking for a potential trade that could hedge and reduce some of the risk of another 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 be talking about the endowment effect and why it cripples investors. My understanding and belief in these different psychological effects or barriers that we have to our potential to be great traders is that we can't overcome these necessarily. But the more that we understand them, the greater the possibility that we have an opportunity to recognize when we are being manipulated by some degree to these different psychological barriers or effects that happen in our mind. And so, this is not to say that we can overcome these by any stretch because it'll always potentially happen to us, but again, it's the understanding and the recognition of them I think that will enable us to make potentially better decisions or smarter trades.

The endowment effect is a really interesting one and I see this all the time and you've probably felt this before and now, retroactively, you might go back and think to yourself, "Yes. I've felt the endowment effect before. I know when I was feeling that and I shouldn't have been feeling that." But it's only after the fact that you realize you're feeling this. But it's this bias that occurs when we overvalue something that we own and it's regardless of the objective market value of the underlying thing that we own. If we buy a t-shirt and later on, we value that t-shirt because there's some sentimental or nonphysical meaning to the value of that t-shirt to us, we just overvalue how much that t-shirt is really worth. It might have been $5 when we bought it, but it's worth a lot to us because it has some brand logo or some affinity or you bought it during a certain time in your life. And so, that's the same thing that can happen in investing. When we go into a potential trade or you make a trade in the market, you overvalue potentially something that maybe doesn't have that much value at all. And so, this was proven back in some research back around I think like 1990, 1991. They proved this in research that people do this all the time. And it's evident that people become relatively reluctant to part with something good that they own for its cash equivalent and again, it's because people are not willing to give up the sentimental value or the extrinsic or kind of non-tangible value of this thing and again, it could be a physical object like a t-shirt like what we're using in our example or it could be something like an option contract where you think it has more value, but the market is telling you that it does not have more value and you're putting on this value that could be greater than what actual market value might be.

Put more simply, look. People place a greater value on things once they've established ownership and that's really what it comes down to. When you own it, you immediately (no matter what happens) put a ton of emphasis on value because now, you have owned it and this is especially true for things that we would normally have bought or sold during the market and it's usually like I said, symbolic or experimental or emotional significance, something out there that basically forces you to take a stand and say, "No. I believe in this." And we see this previously and we talked about kind of this bias around trading, but the endowment effect can impact you because what if you, let's say, made a trade in Tesla or Facebook or Twitter and now that you've made a trade in there, maybe you've even told people you've made a trade. You've publicly declared to other people that you've made a trade. Now, you have more of this endowment effect, this more weight on the value of that trade even though that the trade value hasn't really changed. It's still the same trade. Nothing's really changed other than the fact that now, you're part of it and you've maybe told somebody, but now, there's immediately more emphasis in value placed on the trade which might actually lead you to holding the position longer if it's a loser, to maybe not getting out of it as quickly if it's a winner, wanting to be right, wanting to be correct, not wanting to look stupid or like an idiot in trading and that can really mess with your mind. And I've seen this time and time again with traders, is that they have this ego about them that they want to be right. And again, it's not a conscious thing. It's more of a subconscious thing. People don't even know that they're doing this. But this is one of those major things that could affect it, is the endowment effect.

My hope today is that you understand, first of all, what this is and I think we've done a good job on that, but two is just to understand when this is happening. Set your ego aside for all of the trading that you do because there's no place for it. The market does not care who is the owner and who is selling. The market does not care about that type of stuff. You got to set your ego aside and just realize that the most important thing is generating money and reducing risk and increasing the probability of success of your overall positions. Everything else doesn't really matter as much. Hopefully this helps out. As always, if you guys 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, "What's the difference between volume and volatility?" This is another member question. Somebody sent me a question and basically, it was this. It was, "Some places are saying that if a stock has high volume, then it might also have high volatility or I see that people are mentioning that a stock is moving really high in volume and volatility, but can it really be both? What's the difference between volume and volatility?" The simple answer to this is that volume tells you how much of something is being traded. Volume in the sense of either stocks or options tells you how much of that stock or option contract is being traded. If there's a lot of volume, that means that there's a lot of trading that's occurring, there's a spike in trading activity. Now, this doesn't always mean anything for direction. A high spike in volume for call options could be a hedge and doesn't necessarily mean that somebody is expecting the stock to make a big move higher. But all we know is that there's a lot of volume that's now coming into the market, there's a lot of activity in the market.

On the other hand, volatility tells us how much expected volatility or actual volatility the contracts themselves are seeing that day. If we have, for example, a stock that is making huge moves during the day, it's up $10, then down $20, then back up $10, that's a lot of volatility for that stock price. Now, the stock could also have high volume for that day, meaning that in addition to the huge swings that it's having in the price, it's also a record-breaking day for the number of people who are trading contracts and that, most of the time, is the case. When you have a lot of volume, it's also followed by a lot of high volatility. In the world of options, what we typically associate with volatility is implied volatility or expected volatility. You could have a stock that has a lot of volume, option contracts that have a lot of volume, people are expecting the options to behave or move in a certain fashion in the future and that increases the volume or number of people who are trading, but it also increases the expected volatility of the stock. Now, this doesn't mean that the stock actually is going to make a move. We see this a lot with earnings trades where right before a stock announces earnings, the option contracts have huge volume, lots of people are trading them, the stock is not moving, however, but implied volatility, the expectation of a move in the actual option contracts is being bid up. People are expecting a big move at some point in the future. It just hasn't happened yet.

Understanding these two differences I think is obviously important and it definitely helps you decipher what people are trying to say online. If you're reading a forum post or somebody's article or their tweet about volume and volatility, just really understand what they're kind of talking about and what that means in the grand scheme of options trading. As always, hopefully this helps out. If you guys 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 be talking about the 80/20 rule, but applied to options trading. We all have heard the 80/20 rule in some form or fashion basically that 20% of your inputs is responsible for 80% of the output or 20% of the population holds 80% of the wealth. Whatever discipline or vertical it's applied to, we all know the general concept. Well, I want to put a little bit of a twist and spin on that and tell you that in trading, I think the 80/20 rule applies as following. 80% of trading is psychology, 20% is mechanics and that's the twist that I think you should really hone in on here today and think about over the next couple of days, is that trading is really a mental game. In fact, it's the most mental game that you could possibly be in because you have money, you have moving numbers and charts, you have geopolitical issues, you have consumer issues, global issues, country risk, company risk. There are so many moving parts, it becomes an entire game of just mastering your mind and mastering your psychology, controlling or removing your emotions from the decision, so that you can focus all of your attention on just the things that actually drive results which in many cases is just this 20% mentally is the mechanics.

Most of trading is not a mechanical game. It's very few mechanics. The actual process of entering trades and closing trades and looking at positions, that's the small side of trading, in my opinion. That's frankly the easiest side of trading. The hard part is getting over the psychology, holding through a losing trade and not using a stop loss, taking profits early in the expiration cycle and not being greedy to hold potentially all the way through expiration. A lot of those psychology things, you have to get over and that in some cases, comes with time or could be used… You could use technology to do that. Hopefully, we'll have the ability for you to do that with our auto-trading platform here in the near future. But I think that this concept, the 80/20 rule is really, really interesting if you look at it in a different light for options trading. That's what I want to leave you guys with today. As always, if you guys have any opinions or thoughts, let me know. Hit me up on Twitter, Facebook, wherever you guys can find us. Shoot me an email. I'd love to know what you guys think about this 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 be answering the question, "Does using multiple technical analysis indicators help or hurt?" Now, this is a question that we get often here at Option Alpha, especially since we did the long, long research, about 20 years of data on multiple technical analysis indicators, settings, parameters. You can find that all in our research report called Signals. But my assumption here is that it has to work in both cases and what I mean by both cases for technical indicators is that technical indicators should work like wheels on a bike or like wheels on a car. If you have a car that has four wheels, each of those wheels has to be strong enough to hold the car. You can't have a tire that's flat or else, the car really doesn't move down the road as well as it should or as effectively as it should. But when you have let's say four wheels on this car and each of those wheels worked independently and then are put on the car and worked together as a team, you can get the whole car down the road. When I think about technical analysis indicators, I think about them in two dimensions. One, they have to work by themselves. If somebody tells me, "I want to use this indicator." there's going to be research and data and back-testing case studies that prove that that indicator is actually effective. Now, not even looking at the other indicators, not confirming signals, not other moving averages or RSIs or MACDs, if you're going to use one indicator and even use that indicator in conjunction with some other indicators, it's got to work independently by itself first just like a wheel on a car. That wheel on the car has to be able to get down the road. If that wheel is flat, I don't care what car you put it on, it's still not going to work.

It's got to work independently by itself. Then once we have a series of technical indicators that work independently, now, we can start to figure out what kind of cross indications can we get by using multiple indicators at the same time. Now, I'm a fan of limiting this to like three or four. Probably four at the most is what you might have to use on some of your charting. You start getting over four indicators on one chart and it becomes chart overload and technical overload, analysis paralysis, whatever term you want to use. It's just less and less effective the more indicators you are looking at. In our research, what we found is that there's probably about three… In most cases, depending on if you're going long or short different stocks, there's probably about three indicators that end up working out pretty well independently by themselves, but then together, they give us a better picture of what might be happening. Now, the way that I use technicals is that in my case, all three of my technical indicators have to line up for me to make a strong judgment call on a direction. If I don't get all three of these indicators to lineup at the same time or very, very close to one another, then I'm probably not going to make a strong judgment call. I'll probably just make a neutral trade. But we have used this before over the last couple of years since we did the Signals research, especially when we get assigned stock. We've been really kind of leaning on these indicators as a means for helping us determine if we should hold the stock long or short, depending on how we're assigned the contracts. I think multiple indicators can help as long as you use them the right way. They've got to work independently by themselves and I think you should limit them to three to four and they can definitely hurt if you use too many of them or just flat out using the wrong technicals. For example, like simple moving average. Not a great technical indicator based on our research, so using that in any form or shape would not really be productive to your trading. Hopefully this helps out. As always, if you guys want to learn more information about the technical analysis that we did, head on over to optionalpha.com/signals. Again, that's optionalpha.com/signals.

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 to protect long call option profits?" There's three ways to technically do this. I'll go through them here on today's podcast. Again, we generally don't suggest that you trade long call options. It's not really a trade that generates high expected overall returns. But if you find yourself in a position where you did for some reason feel a little bit lucky and you wanted to trade a long call option, you have some profits in place, how do you basically protect those positions?

The first thing you could do is sell the position. This is pretty simple, actually and probably my most suggested option to do is just get rid of the position and take your money off the table. If the market gives you a favorable move and it happened in a short amount of time to where time decay is not ripping the value out of these long call options, then your best choice might be to just simply sell back the call option to close and remove the position. The second thing that you can do is you can then buy a put option. You could buy a put option. This would effectively turn the position into a straddle. And buying the put option would be a little bit more costly because you have to outlay capital for the put which would increase your breakeven points overall, but again, it could protect you in case you think that the stock is going to make a huge move in the opposite direction. Now, the problem with this strategy is that you basically, like we had said, turned this thing into a straddle or to a strangle which means that now, you are no longer directionally long the security. You're looking for the security to make a huge move in either direction. Yes, it does help protect against potentially the stock going down, but at what cost? At what cost do you have to widen the breakeven points, outlay capital to buy insurance?

The third way that you could do it is you could turn it into a spread. You could sell a call option above where your long call option is or above where the stock is trading at this time, collect some premium by doing that and basically turn this position into a bull call spread. Now, this doesn't do much though because you basically still have all of the downside risk of the call option going down in value, but by selling the call option above where the stock is trading or above where your strike price is, you might capture a little bit of premium to pad some of that downside movement. Again, the real limitation to this one is that if the call option goes up in value from say $100 to $1,000, selling a call option is not going to reduce the risk that that call option then goes right back down in value from $1,000 to $100. Hopefully this helps out. Again, just kind of helping you guys out with different strategies as we always try to do here at Option Alpha. If you have any questions, let me know and next time, happy trading.

Hey everyone. This is Kirk here again at Option Alpha and welcome back to the daily call. Today, we're going to be talking about the wheel options trading strategy for beginners. Now, the wheel strategy is a really unique option strategy that you can use if you're just getting started in options trading and you're not quite comfortable trading a lot of risk defined spreads or iron butterflies, iron condors, etcetera and you just want to kind of stick to some basic premise strategy that you can use. Now, the wheel strategy is something that we've talked about in-depth on one of our weekly podcast where we actually interviewed one of our long time members and fellow trader, MACDDaddy on show number 107, so if you want to jump over to the weekly show, you can hit up show number 107 and hear my interview with him. He's been trading the wheel strategy for a really long time and put together some great resources for you that you can use.

The basic premise of a wheel strategy is the following and it's made to sound like a wheel because you could do it in a complete cycle over and over again as many times as you want. But you start off with a short put option and I would typically start off with a short put option. I guess you could start with short put or long stock. It doesn't really matter. But I would say you start with a short put option. You sell a put option on a stock that you are willing to own at some point in the future, so you like Tesla, you like IBM, you like something else. You sell a short put option, collect premium. You keep selling short put options until the point at which some time in the future, you're going to be assigned stock. At some point, the stock is going to drop and it's going to go below your strike price and you'll be assigned stock. At that point, you take delivery of the stock and you are now long stock in that contract or that stock or ETF that you wanted to be long in. The next thing that you would do then to continue moving around the wheel is you would sell covered calls against that stock position. You take delivery of the stock. Let's call it Netflix or Tesla. Now, you start selling covered calls against Netflix or Tesla and try to reduce the cost basis as much as possible. Now, at some point, the stock is going to rally and it's going to go beyond your short call option strike price at which point that you just let the stock be taken away by the short option contract. And so, now, you're left with no calls and no long stock, so what do you do? You now go back all the way back around and you start selling put options again. This is what kind of completes that little wheel or circle if you want to think about it that way, is you just continuously sell put options until you're assigned stock. Once you're assigned stock, you sell covered calls until you get assigned on those covered calls and have to give away your stock and then you go back to selling put options again and you just continuously move in this cycle and this kind of ebb and flow around the market.

Again, it's a really unique strategy, a really interesting strategy. A lot of people like it because it's very simplistic in nature. It's very easy to follow and understand. I think there's a lot of things that you can improve on it and obviously, it uses stock positions which are very capital intensive. But again, as a beginner, it might be a really good strategy at least to start out with just a very small ETF position and start using the wheel strategy around it. Again, as a reminder, we did do a long interview with MACDDaddy, one of our great and long time members here at Option Alpha on show number 107, so if you want to dig deeper into the wheel strategy, check out show number 107 on the weekly podcast. 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 be answering the question, "Are there any advantages to letting options expire in the money?" And yes, we are talking about options that are in the money. This means you could have long options that you want to expire in the money or short option contracts that you're choosing to let expire in the money. And to me, really, the only advantage is stock ownership in one form or another. That would be the only advantage to me in letting contracts expire in the money. First, let's take the assumption that we are a long call option buyer or a long put option buyer and we want the stock to expire in the money. The only reason that we would want that to happen would be to convert our option position into short or long stock. Again, there's no real pricing advantage to it because at the end of expiration, the option contracts are going to trade basically in parity with the stock if there's any value left in them. You do have the disadvantage of having to go through the commission process and in many cases and with most broker platforms, the commissions to exercise or get assigned contracts are pretty high. But again, if you have the assumption that you wanted to get delivery of or wanted to be long or short the stock, then you could let it expire in the money.

Same thing would be applied in reverse for option sellers. If I'm an option seller and I sell a call or sell a put, the only "advantage" would be to let the option expire in the money if we wanted to get assigned short or long stock. Again, if we were shorting puts and we knew that we would be okay and willing to buy stock at the strike price, then maybe we let the option contract expire in the money and we are forced then to buy the stock at the strike price that we sold on the put side. Again, the disadvantage to all of this is the capital that's required to hold the underlying stock. It's much easier to use a stock synthetic using options which we've talked about in previous podcast and have video training on the website and in my opinion, we also remove the risk of commissions which in many cases, can be very high, sometimes $15, $20, $25 per contract to go through the assignment or expiration process. Although there are maybe some slight advantages if you even want to call them advantages, I am still a fan of closing positions before expiration even if they're in the money. If you want to buy stock, then go out and buy stock at the new market price. Just remove the option contract. You'll pay a cheaper commission and it'll ultimately be a more simple process for you. As always, if you guys 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 I close out of a bull call spread?" Closing out of a bull call spread also commonly referred to as a bull debit spread which is an option buying strategy is actually just as simple as reversing the trade. To understand how we reverse the trade, we first need to understand what the core position is of this bull call spread. This spread trade is created by buying one in the money option contract and selling one out of the money option contract both on the call side of the option pricing table. For example, if a stock is trading at $100, you might buy a 99 strike call option and sell a 101 strike call option. This creates a debit and that's why it's an option buying strategy. Again, this is not necessarily the exact way you have to set them up. This is just how we would set them up if we were trading them here at Option Alpha. If you are long a 99 strike call and short a 101 strike call option, then the process of removing the position and closing it out is as simple as just reversing the trade. What we would do is we would end up selling back our 99 strike call and buying back our 101 short strike call option and closing the position. This would hopefully result in a net credit that is higher than the net debit that you paid to enter the position, therefore, leaving you with a profit on the trade. As always, if you guys 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, "Do I need a margin account to trade a covered call?" The short answer to this is no, you do not need a margin account to trade a covered call. The beauty of trading covered calls is that they are covered by existing stock positions in your account and that's why most brokerages will allow you to trade covered calls because you're selling options, but it's completely covered and therefore, no additional margin is necessary by the underlying stock that's in your account. Now, I would highly suggest, however that if you are serious about trading options and continuing to use options trading as a source of income either now or in retirement that you start to apply for margin accounts or start to open margin accounts that allow you to trade more complex strategies and tickers. In particular, what we found is that trading covered calls while could be profitable for many different market scenarios is usually a big drag on your equity and capital because you actually have to buy the underlying stock. There's more effective alternatives or synthetic covered calls including short puts and the poor man's covered call which is also tying in a leap option contract that's at a further out date that you can use and those are mostly required to be traded in margin accounts. Again, yes, you can trade covered calls even if you don't have a margin account, but it's highly advisable that you get a margin account, so that you can trade some more strategies that ultimately I think will improve the performance of your portfolio more so than trading just covered calls. As always, if you guys have any questions, let me know and until next time, happy trading.