Too many questions

I had this question from a reader:

How do I find candidates to trade and decide which strategies to adopt?

I recommend choosing strategy first. Candidates next.

You want to know what to trade and then which how to select candidates? What else is there? Except for risk management, that is 100% of the game. No one can do this for you.

Most brokers provide free scanning software that allows you to find stocks that suit your criteria. But what are your criteria and how are you going to chose them? Earnings growth? Cash flow acceleration? Increase in revenue?

Will you pick a stock or an industry? Then how will you find best stock in that industry? Maybe you are looking for stocks to short?

How can you rate the company’s management? Where are you going to find information that gives you an idea about how the company is really performing? Prepared to read all annual (and all other) reports. Can you interpret the results of your readings? Can you understand all the footnotes to the financial tables? How in the world can you (or anyone) know enough about a company to buy its shares?

The answer beats the hell out of me. I have no clue.

There are too many questions

I don’t see how anyone can help you.

Let’s assume you want some long-term investments. That may be holding the stocks (or deep ITM calls) unfledged. It could include writing OTM covered calls.

Then you also want a trading portfolio, using options. How much of your total should this be? Not too large until you become convinced (and there is always that chance that that may be ‘never;) that you can do far better with options than with long-term holdings.

Then you can speculate with a portion, but that’s not for me and I do not know if it’s for you.

Do broker’s tools help or do they represent a trap? Good question. Depends on which tools you mean.

a) I trust scanners to scan for candidates that meet your criteria.

Paper-trading tools are innocuous (except for one broker). Most give such poor fills that it encourages no one. However, that un-named broker gives good fills in practice accounts – and I believe that is to convince newbies that trading is much easier than it seems. Those good fills entice traders. I’m convinced of that.

No one can pick candidates for you. Do you like nonvolatile stocks that pay big dividends? Do you you want to be long technology or biotech? Do you even want to be long, or do you want to be carefuller hedged? Do you want to trade individual stocks or an index/ Are you willing to take the chance that an individual stock may issue a bad news alert.
Do you want to be neutral, or even short the market?

With all those questions and many, many more, who can make recommendations for you? The obvious answer is the correct answer. No one but you.

You must find your own underlying or be able to explain in detail to someone else just what you are looking for and then trust them to give you a bona fide list.

And then when you find these stocks, what are you going do do with them? Buy and Hold? Collar? Write ATM or OTM covered calls?

Are you going to buy the shares, or buy call spreads? Perhaps sell OTM put spreads. Are you going to seek limited or unlimited returns? Is it worth all that research to seek limited gains? How much risk are you wiling to take. can you afford a market crash?

Those are merely the questions,. Next you must supply the answers and decide which are most important.

I hope you can find the path, It is difficult. Most investors just do whatever is in front of their noses and hope for the best. That is not wise.

Idea

Pick a broad based index or ETF. Trade small. Choose a strategy that you believe you understand. Pay close attention to the trade and adjust if necessary. Make a trade plan. Continue to trade other strategies in a virtual account In six months you will have a lot of experience with a couple of strategies and may have even discovered a candidate or two.

Then it’s time to get started. Small size and grow size very slowing Prove you can make money before expanding. Do nto believe you can do it until after you have proved that it can be done (by you). Have patience. Many questions. Many answers. Just begin slowly and do your research.

12 Responses to Too many questions

  1. Jack 05/20/2011 at 12:25 PM #

    Mark — On the theme of what to trade, I’ve been trading credit spreads on RUT and AAPL. I’ve noticed that there are no RUT options for August (or for October or November, for that matter). I can’t imagine why a major index wouldn’t have options every month. I guess I could trade IWM for August, but I think commissions will be higher. Do you expect that RUT options for August will become available? If not, what do you trade in its place? Thanks.

    • Mark D Wolfinger 05/20/2011 at 12:33 PM #

      Jack,

      There will be RUT options for August – after May options expire. This is the standard system. No underlying has options that expire every month,. This is a standard protocol for issuing new options.

      Then after June, we would get Sep – except that we already have them. After July expires, we get Oct.

      • Dmitry 05/20/2011 at 1:04 PM #

        Why SPX does already have Aug traded? I dont get it. RUT currently has Jun Jul Sept Dec for this year; SPX – Jun Jul Aug Sept Dec + 3 quaterlys (btw quaterlys look like a good candidate for short term adjustments, sadly RUT doesnt have them).

        • Mark D Wolfinger 05/20/2011 at 2:25 PM #

          Dmitry, Jack, Wayne etc,

          There is a standard protocol for issuing new expiration months and it has been in place for years.
          To be honest, I never talk about it because I thought everyone understood.
          Once an option month reaches expiration, it is replaced by a NEW month.

          This is the protocol:

          1) Every underlying has options in the front two months. Right now that is May and June

          2) When May expires, to continue that idea, every underlying will have Jun and Jul options. If it does not have Jul, then that is the month added.

          3) IN ADDITION TO THOSE, every underlying has two more expiration months as follows

          a) There are three quarterly cycles:
          Jan Apr Juy Oct
          Feb May Aug Nov
          Mar Jun Sep Dec

          b) Every underlying has the two nearest months of its cycle listed for trading: such as Jul and Oct (see IBM options)

          If it already has one of those months listed – i.e. if it already has Jul, then options that expire in Oct and Jan will be available (Oct is already listed, so Jan is the month added)

          If the cycle is Feb May Aug Nov, then it will have May Jun Aug Nov now and Jul will be added next week.

          3) Some stocks also have LEAPS options that expire in Jan 2012 and 2013 with 2014 to be issued as needed – when the Jan 2012 becomes a ‘regular’ option. Look at IBM. It already had Jan 2010 because it has LEAPS. Thus, Jan 2014 gets listed.

          4) Indexes are different. They have their own rules. June and Dec are always available.

  2. Wayne 05/20/2011 at 1:14 PM #

    Dimitry and Jack,
    I called my broker the issue you brought up: when certain options are listed and when not.
    They referred to CBOE. I called CBOE and they have their own rule as to which options are trading in which month.
    Please read below: the top shows the month we’re in the bottom which month the RUT is open to trading:

    MAY JUN JUL AUG SEP OCT NOV DEC

    MAY JUN JUL AUG SEP OCT NOV DEC
    JUN JUL AUG SEP OCT NOV DEC JAN
    JUL* AUG* SEP OCT* NOV* DEC JAN* FEB*
    SEP SEP DEC DEC DEC MAR MAR MAR
    DEC DEC MAR MAR MAR JUN JUN JUN
    MAR MAR JUN* JUN JUN SEP* SEP SEP

    This is for RUT. Dimitry: I can ask for SPX for you later.

    • Mark D Wolfinger 05/20/2011 at 2:28 PM #

      Wayne,

      Your broker sent you to CBOE because they are ignorant of the rules.

      I don’t know what you posted, but it is gibberish to me. I’d prefer to delete it so as not to confuse anyone.

  3. Wayne 05/20/2011 at 5:46 PM #

    Yes, the list provided to me by CBOE is difficult to read at first sigh. But it makes sense; The top line shows the month we’re in. Below that month are the options series available for trading. I listed May through December. But you’ve got to read it vertically [MDW: Yes, a minor point you neglected to mention!] Their list shows May through December, but let’s just look at May and December

    In May, options series available: June, July, Sept, Dec, Mar
    In Dec, options series available: Dec, Jan, Feb, Mar, Jun, Sept

  4. Mike Z. 05/20/2011 at 8:58 PM #

    Mark, I’m trying to understand the bull put spread, so be patient, I’m a novice. My stock, ABC, is at $33 a share. When choosing a strike price for this spread, let’s say I’ll buy the 30 (long put), and sell the 32 (short put). First, should the short put be in the money? And second, should the long put be out of the money? Is there a general rule about whether the long put or short put should be out of the money or in the money? If you could give some guidance, I’d appreciate it. Thanks, Mike Z.

    P.S. I believe that the goal is for both the short and long put to end out of the money. Therefore, doesn’t it make sense to choose both out of the money puts?

    • Mark D Wolfinger 05/20/2011 at 9:41 PM #

      Mike,

      Requesting patience is reasonable.

      First: No the short put does not have to be in the money. In fact, most traders prefer that it be out of the money. This offers less profit potential if the stock rallies, but as compensation, you can earn a nice profit, even if the stock declines (by a small amount) when you sell an out of the money put. Most traders prefer that situation because being bullish does not always mean that the stock will move higher.

      Second: Yes. There are better (easier) trades for the bullish investor. There is no need to sell a spread when both options are in the money.

      There are no true guidelines because each trader is different and has a different goal and tolerance for risk. But if you are a beginner, it is truly best to begin by choosing spreads for which BOTH options are out of the money. the position is easier to manage and it is easier to earn a profit – higher probability of winning (although a smaller profit).

      Third: Regarding your closing question: ‘Make sense’ is not quite the way I would put it. But, I agree with the sentiment.

      When both options are out of the money at the time you initiate the trade, then there is a significantly higher chance that the will both be out of the money (maximum profit for you) when expiration arrives. High probability of success is a nice feature when trading.

      Please be aware that the potential profit is less and the potential maximum loss is greater – when both options are out of the money. Do not let that frighten you. However: BIG WARNING: Do not believe this is free money. DO NOT trade too many spreads at one time. Calculate the maximum loss and be absolutely certain you can stand that result before making the trade. Choosing how many spreads to sell is the number one risk management tool.

      Regards

      • Mike Z. 05/20/2011 at 9:51 PM #

        Thank you for your patient analysis, I will think about what you wrote.

  5. Dan 06/03/2011 at 11:44 AM #

    Mike,

    I like trading RUT spreads but im not sure if its better to place a spread order or just leg in. Does a spread order make more sense with a smaller order? I can see trades occuring at the spread price i want but i fail to get filled.

    • Mark D Wolfinger 06/03/2011 at 12:11 PM #

      Dan,

      Legging in is far more difficult than you imagine. I’d like to provide a more detailed reply in a blog post. Look for it early next week.

      I doubt Mike will see your question and I have no way to reach him for you