Finding a Trade Opportunity

Hi Mark,

I just by chance found your blog and read a few lines… Probably
you already wrote that – but I just can not resist at this point to
repeat the part of the question above – how do you "find" your trades –
or which are your preferred strategies?

Thanks a lot!



My reply indicates how I operate.  Some traders appreciate the simplicity of my methods.  Others shrink in horror at the apparent randomness of my choices.  I must tell you that I do NOT recommend the method described below as a good idea for everyone.  You must (please) think about it and decide whether it's appropriate for you. 

Many people time their trades, with a market bias.  That's 'normal' procedure for traders.  I admit an inability to know where the market is going next, so I just trade when other conditions are met.

The strategies that appeal to me have one thing in common: limited losses and limited gains.  Risk management is far more important to me than seeking giant profits.

You can find potential strategies by reading this blog, Options for Rookies.  If you prefer books, I wrote The Rookie's Guide to Options for people who are looking for answers to questions you raise.  There are also other educational materials offered at no cost online. 

If you understand how a specific strategy works, you should be able to decide if it 'sounds' good enough to try.  And by 'try' I mean a paper-trading account.  Don't use real money until confident that you understand the trading method.

Then experiment with another strategy – until you find one that just feels right.  You will like the risk/reward potential. You will like the probability of earning a profit vs. the probability of losing money.  You will feel comfortable that you know what to do if trouble looms.  In other words, you 'get it.' 

It's important to acknowledge that this is not your lifetime strategy.  As you gain experience, as market conditions change, so will you.  Thus, if you decide to change methods, or modify your strategy of choice, that's more than okay.  It's a smart thing to do.

If you are brand new to options, it will take some time.  If you already traded options, pause, consider several strategies and practice one or two of them until you are sufficiently confident to use real money to trade.

I cannot tell you how to find trades.  If you are into technical analysis, then you can adopt bullish, bearish, or neutral strategies.  I always choose the neutral plays.  But, most traders prefer to express a market bias when investing.

What I do to find my trades works for me.  I don't have any idea if it will work for you, so please do not copy it unless you feel it fits within your comfort zone:

When I am ready to put more money in the market – and the timing is when I have extra cash, not when I predict any special move – I trade an iron condor (market neutral) on the Russell 2000 Index (I prefer using only one entity because it makes my portfolio easier to manage.  You may prefer more diversification).

I choose specific options to trade based on MY comfort zone: 2-3 months prior to expiration; as far as possible out of the money such that I collect about $300 total for the tqo 10-point spreads; and I check the delta of the options traded, preferring to sell options with a delta lower than 15.  That 15 delta suits me.  Many prefer delta in the 8-10 range.

If a suitable trade is not available, I wait.  No urgency to put money at risk.

My specifics probably will not help you – I list them to get you to consider alternatives that meet your needs.  You truly want to find your own zone of comfort.


17 Responses to Finding a Trade Opportunity

  1. Andy 01/16/2010 at 11:23 AM #

    wondering about your criteria for finding a trade… lately a 2 month, 10pt RUT spread or iron condor with a delta of 15 will only net you ~$1.5 not nearly $3. Have you been holding off on new trades lately or using other methods?

  2. Mark Wolfinger 01/16/2010 at 11:59 AM #

    I have not been adding much lately. Have more cash st aside than I prefer.
    If the 20month premium is so low, I use 3-month. If that’s too low, I decide whether to accept $2.80 or or even 2.70 – or to sit on the sidelines. there is nothing magical about 3.00. That’s my approximate price.
    When markets are calm, premium is less. But, so is risk of a big move. A decent trade-off.
    I usually trade at least a few lots, just to start a position. Then add if and when I like the prices.

  3. Jared 01/16/2010 at 6:39 PM #

    I was wondering how you execute your trades in the RUT. Do you start at the mid point and then move down $.05 until you are filled (Max of $.15)? Also, is it ever advantageous to leg into an Iron condor? For example, buy the call, buy the put, sell the put, sell the call taking no more than a few minutes to complete the trade? Would this get you a better fill in the RUT than doing it all as one order, or is it even worth the aggravation?

  4. 01/17/2010 at 8:08 AM #

    …So when you mentioned, 300$ per 10 pts spread, meaning your margin is 1000$ for the iron condor. Would it be correct to assume you will get 30% return when all expire worthless? Thank you Mark…

  5. Mark Wolfinger 01/17/2010 at 9:37 AM #

    Margin for the position is $1,000 – but some brokers (Fidelity) require a $2,000 margin.
    You may use the cash to meet margin requirement. Thus, true margin is only $700 for a 10-point IC when you collect $300 cash for the trade.
    Yes, that would be a 30% return on the $1,000 margin.

  6. Mark Wolfinger 01/17/2010 at 9:46 AM #

    1) I do not start at the midpoint. My broker passes along cancellation fees, so I try to avoid making changes to my order.
    I begin 10 cents worse than mid-point. With little luck at that price. Sometimes I move to 15 or eventually 20 cents. But that truly depends on how badly I want the trade.
    Trading 3-month, OTM options means I must trade with market makers. There’s not much trading volume in these options.
    2) If you don’t pay those fees, I would begin 5 cents worse than mid-point. I’d wait a few minutes and then move to 10-cents.
    This is truly a trial and error experience. Under some market conditions, the MMs will be glad to grab your offers. At other times, they could not care less about your order.
    3)The reason I don’t like legging into each option separately is that there can be a quick shift in market sentiment and you may find it very difficult to get one or two of the trades at a decent price. Just one of four trades going badly offsets all gains.
    But, I have never tried this, and cannot give you a reply from experience.
    If you want to buy a strangle on a leg and then sell the other (more costly) strangle, that may work.
    For me, the problem is order execution. If you trade front-month options and if there is any reasonable trading volume in those options – then by all means, experiment and see if your method works. But if you must depend on the market makers for fills, I don’t see how this can do you any good.
    Worth the aggravation? First you must determine how much you gain – if anything. Then put a dollar value on your time.

  7. TR 01/17/2010 at 12:53 PM #

    I have a question for you on overall portfolio theta, and I was curious to see whether you pay a lot of attention to this.
    I found my portfolio having negative theta last week during Janury expiration week. This was no doubt driven largely by my January stangle that I had (1 lot RUT 560P/660C). The strangle was protecting my February IC’s (10 lot RUT 520/530/680/690) and March IC’s (13 lot RUT 500/510/710/720). I did also have more protection in the form of a February Strangle (1 lot RUT 550P/690C) and February 1×2 Kite (RUT 1x660C with 2×670/680 spreads). The sum total of my positions left me slightly negative theta last week which is something I have not encountered before. The negative theta situation dissapeared on expiration Friday when my portfolia theta jumped to about 40 (after my Jan stangle expired worthless). Early in the week I did consider selling my Jan strangle (for about $150-200 depending on the day) but when I analysed my profit curve without this strangle it seemed like the stangle was making a huge impact on the curve (especially on the upside), so I chose to hold on to it.
    What are your thoughts on this situation? Would you have sold the January strangle earlier rather than hold it through to expiration?
    Also does it make sense to watch theta and add/remove insurance accordingly (i.e is seeing too high a theta a sign of too much risk, and too low a theta a sign of too much protection?). I have noticed that generally for my portfolio theta is around 30-40 when I have my usual 20 lots of IC’s in Month 2 & 3, coombined with a stangle or two for protection (and this theta of 30-40 usually feels right to me).
    I know you talk about negative gamma a lot (so I suspect you watch gamma closely), and I have heard that theta & gamma work as opposites. So is watching theta and attempting to keep it in a certain range a good thing or do you feel like I should pay less attention to theta and more attention to gamma.
    I think part of the reason why I have felt comfortable watching theta is that I can relate thata to the amount of money I am making in time decay per day and if this number is too high I intuitively relate it to me taking on too much risk (i.e. I am making too much money for my investment for it to feel safe), and if theta is negative I can view it perhaps having too much protection. I find evaluating gamma much less intuitive for me.
    I am looking forward to hearing your thoughts and learning from you. Thanks again for this awesome blog.

  8. Mark Wolfinger 01/17/2010 at 1:14 PM #

    Thank you.
    1) When you are long the near-term – and especially when it’s a day or two prior to expiration, the theta becomes enormous.
    My advice is to ignore that theta and only look at the total theta – minus the (in this instance) Jan options.
    2) Then, as a separate decision, you must decide whether to hold the Jan options. You gain the protection it affords, but that protection disappears quickly as theta takes it’s toll.
    It’s a separate decision.
    3) I would have kept the 660 calls if i needed the insurance.
    Or you could have sold it and replaced it with something different.
    I would have sold it – if and only if – I deemed it unnecessary. However, there has to be some price limit. It’s not not worthwhile to sell it for peanuts. After all, big news does occur every once in awhile and markets do gap.
    How much TR wants to pay for insurance against that occurrence is simply up to you. Surely it’s worth $10. $100 may be too much. It is a personal choice.
    I do sell out my insurance when I exit the trade it is protecting. The insurance is no longer needed.
    4) The most difficult part involving protecting a portfolio is the negative theta that comes with it.
    Not everyone is willing to pay that theta. After all, when selling premium, theta is your profit motive. As you say, you watch that number carefully.
    I sometimes carry negative theta. I work out of it gradually – not in a panic. I usually do that by trading more iron condors. I’m not building big size. The reason I have negative theta is that I have far too few iron condors remaining in my portfolio (as I do right now). In other words, I am overprotected.
    5) Yes they work as opposites. Long options is Positive gamma and negative theta.
    6) One possibility which I don’t use – but others whom I respect do use – is a calendar spread as protection.
    But, this is limited protection and if the market moves too far, those spreads lose value.
    If you do buy OTM calendar spreads, it’s important to sell them when OTM becomes ATM (or close). You cannot afford a continuation of the move. The original position is in trouble, the calendar has done all it can – and will become a loser if the move continues.
    This works ok for active trades who constantly monitor portfolios.
    Of course, a simpler version is the diagonal or double diagonal – but that is long lots of vega and presents a whole different risk.
    7) Agreed. Theta is an excellent method for keeping track of risk. Not foolproof. But it does provide a decent picture.
    If gamma is less intuitive – that’s ok. Just keep an eye on the risk graphs. Those are easy to interpret.

  9. TR 01/17/2010 at 5:51 PM #

    Thanks Mark. This is very helpful.

  10. Jared 01/17/2010 at 6:06 PM #

    Thank you for the reply. The only reason I would even consider to do them all separately is that I have heard that MMs like to work with single options or two legged spreads, and that sometimes it can be hard to get a 4 legged spread executed at a good price. Do you think this is true? Also, how long should I wait to change my order and drop it down $.05 (I am not charged a cancellation fee)?

  11. Mark Wolfinger 01/17/2010 at 7:09 PM #

    You must remember that if you are like most individual traders your order of one to 20-lots is of minor interest to the MMs. In fact, 1-5 lots are annoying.
    Without decent size (and the big risk that goes with taking legs), the MMs are unlikely to show any interest in your orders.
    My assumption is – and that’s all it is, an assumption – is that when I enter the 4-legged order, no MM is bothered with it. I believe the MM’s computer (along with every other MM’s computer) sees the offer and ‘decides’ whether to take it or not. Like I said, a guess on my part.
    Electronic orders are not like the old days when a broker entered the pit, announced the bid, heard counter offers and a trade was made, or not. But everyone knew the order existed This time the order appears electronically, and no one may notice.
    I know for a fact that orders can go unnoticed if they sit for awhile.
    I have canceled orders (asking $3.20) and immediately replaced the order with a higher asking price. Filled instantly. That must mean no MM was aware of my standing order.
    Back to the question: If not filled in a minute or two, there is little chance of being filled, unless the market moves, IV changes, or something makes the order appealing.
    Thus, drop it a nickel at that time. You can use pennies if you have the patience. Wait longer next time (but not much longer). Keep doing that until you don’t want to drop it any longer. Tomorrow is another day.
    I do believe MMs prefer hedged positions – and that means the two-legged spreads make for a decent legging opportunity. BUT – and I have written about this before – if you leg into a call spread and the market rises, the higher prie, coupled with a small decrease in IV makes it very difficult to get anything but a poor fill on the put spread.
    If you leg the puts first, and the market falls, the higher IV may still allow you to get a fair price for the call spread.
    I just don’t believe there is anything significant to gain by legging – unless it’s for a couple of days and you want tow wager on market direction.
    I do the 4-way, knowing I may be taking a little less than I could get on the individual call and put spreads.
    Experiment and see how it goes. Don’t get stubborn.

  12. Steve 01/18/2010 at 4:36 AM #

    Hi Mark,
    Just wanted to get your thoughts on borrowing money to trade with.
    A work collegue recently took out a top up to his home loan to have extensions done to his house. The quote he got for the work was too much for him and so he had this extra $120,000 lying in his bank account. Of course, he decided to use it to trade with!!
    He is of the old school buy and hold stock and hope for the best type 🙁
    He doesn’t use options for protection and thinks in 20 years he will be set up!
    I hope he is lucky!

  13. Mark Wolfinger 01/18/2010 at 8:54 AM #

    This is a very bad idea.
    Unless he his name is Goldman Sachs. That would allow him to take big chances, and walk away either a wealthy man or broke. If broke, he could just ask Timmy Geithner to bail him out.
    Without that bailout guarantee, I believe this is beyond stupid and he is depending on being lucky.
    1) He may not get 20 years. What happens if there’s another collapse and he loses far more than half of that cash quickly.
    He’s just another someone who believes the stock market can only go higher and that the world owes him a living.
    2) Of course, he can get lucky. Rampant inflation would allow him to repay with cheap dollars.
    3) Betting with borrowed money is using leverage. But, IMHO, losing most of that capital would be far more devastating to his financial health than the benefits he expects to collect.
    4) He is paying interest on that money, so profits are not enough. He must earn more than he is paying in interest.
    5) Old school? Old school? The old school is far more conservative than this person.
    6) He is gambling his financial future. He is allowed to make that choice, but does his family understand what’s involved? He is gambling their futures as well.

  14. Jared 01/18/2010 at 9:53 AM #

    Thank you Mark.

  15. Burt 01/21/2010 at 12:54 PM #

    Mark, I hope you see this since this post looks to be a couple days old. In any event, you say that if the two month premium is too low, you go out three months. But how can you get a higher premium without raising your deltas or hoping for a significant difference in implied volatitlity between expirations? That is, if you keep the same delta and move out to 3 month options doesn’t your premium decline? Or are you keeping the same strikes for the three month as you did for the two month? If you do allow your deltas to creep up, why would you accept the additional risk? Thanks for answering my questions.

  16. Mark Wolfinger 01/21/2010 at 1:32 PM #

    I am notified of all comments via e-mail. Thus, I see them.
    I don’t know if anyone else see the response. That can be a problem for me.
    Additional risk yes. But also additional reward, so there is some balance. I am NOT claiming that this trade gives me a mathematical advantage.
    I find that by moving one (occasionally two – especially with puts) strike farther OTM, and one month out in time, that I collect more premium.
    In other words, I would expect the 90-day call spread with 800/810 strikes to be priced higher than the 60-day, 790/800 spread. I may be able to do the 90 day 810/820 instead and get a higher premium.
    This is one of those times when I choose not to pay attention to delta. I don’t mean I ignore it, but I’m willing to sell that slightly higher delta for the ‘perceived’ safety of being farther OTM.
    Of course, the delta tells me that the probability of the option finishing ITM is higher with the three month option – but because I plan to close earlier than expiration, the true delta for my trades should be determined by using the estimated closing date rather than expiration day. In reality I don’t make that calculation.
    In the scenario you describe, I just ‘feel more comfortable’ with the 3-month IC than the 2-month.
    This is not a suggestion that anyone else do this. And from the perspective of seeking the highest expected return and trading with the mathematical odds as favorable as possible, this quirk of mine does ignore those considerations. Comfort has its place and if I take a slightly less attractive position because I prefer it, I don’t mind.
    Placing a bad trade which is at a significant mathematical disadvantage does not pay, and I would not do that.

  17. Burt 01/21/2010 at 5:37 PM #

    Mark, Thanks very much. Your response was very helpful.