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A Fundamental Introduction to Japanese Candlestick Charting

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A Fundamental Introduction to Japanese Candlestick Charting © Copyright 2018 TheoTrade, LLC. All Rights Reserved 1 TRADE LIKE THE FLOUNDER An overview to Matt’s trading style, methods, thoughts, and insights © Copyright 2018 TheoTrade, LLC. All Rights Reserved 2 Acronyms and Shorthand Cheat Sheet • PnL – Profit and Loss (P. and L. → P n L) • IV – implied volatility • IRA – Individual Retirement Account • Vol – Volatility (typically, IMPLIED volatility) • DTE – Days to Expiration • Roll – move an option from one strike and/or expiration to a different strike and/or expiration • ATM/ITM/OTM/DITM – At the Money, In the Money, Out of the Money, DEEP in the Money • Legging – trading a piece of a spread by itself instead of the whole spread • Skew – the difference between supply/demand (or IV) at different strikes or expirations • Front month – the shorter-dated contract of a multiple-expiration spread • Back month – the longer-dated contract of a multiple-expiration spread • Opex – Option expiration © Copyright 2018 TheoTrade, LLC. All Rights Reserved 3 PART 1 – WHAT KIND OF TRADER AM I? Vehicle, products, time frames, structures, targets, etc. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 4 What do I prefer to trade? Ask most people that question, they will tell you what PRODUCTS they like to trade (GOOG, AAPL, VIX, etc.) but before you settle on a product, learn WHAT you’re trading. Things you can trade: Direction (up or down) Volatility (IV vs. HV) Correlation/Relative Strength/Beta (Pairs Trading) Mispricing/Difference in pricing (Pure arbitrage) Order Flow (HFT) M&A/Special Situations (Merger Arb) Almost ALL retail traders trade direction. I primarily trade volatility. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 5 Volatility trading defined Volatility trading involves making a bet that predicted volatility (the amount of movement the market thinks will occur) will differ from realized volatility (what actually happens post-prediction). As efficient as the market is, it almost never gets it right, with exception to major, major products. We can bet that the product will overshoot its implied volatility (long vol) We can bet that the product will undershoot its implied volatility (short vol) I’m almost always found on the short vol side of the spectrum. There is a risk premium associated with being short vol that can be harvested with proper risk management. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 6 Volatility trading vehicles For the most part, volatility trading is done with options, with the exception of trading the volatility futures product VX. Since options carry a prediction of future volatility and stock does not, we must use options to construct trades to express our volatility opinions. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 7 What products do I trade? I trade anything with “juicy” implied volatility. As a premium seller, I seek to capture the risk premium in every contract I sell. Let’s look at a few examples: Product Price per Share Implied Volatility 20% OTM Premium @ ~60DTE AAPL $170.41 24.97% $0.32 SRPT $127.87 74.74% $5.40 OLED $110.71 46.06% $1.37 NFLX $347.57 45.61% $5.35 NVDA $148.17 48.18% $2.64 TSLA $305.80 61.97% $7.60 XLU $55.68 14.44% $0.05 © Copyright 2018 TheoTrade, LLC. All Rights Reserved 8 Liquidity Concerns I sell options naked with plans to expire them or close them for nickels or dimes. As such, I don’t care about liquidity. I’ll enter as the sole OI for a strike without concern. If I can get my target entry price/IV level, I’m happy knowing that in all likelihood, I’ll just hold the short position until it expires. If you are trading in and out of a product, you must have liquidity! © Copyright 2018 TheoTrade, LLC. All Rights Reserved 9 What Time Frames do I Trade? I’m primarily a swing trader, taking short vol positions with a 2 week to 3 month maturity window. Anything shorter than 2 weeks becomes highly exposed to very small changes in the underlying (gamma effect) and anything more than a few months out becomes highly exposed to changes in supply and demand (vega effect). I’ll also do dividend capture trades and earnings trades as overnight trades, but the bulk of my trading is swing trading. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 10 What Structures Do I Trade? The main structure for a volatility trader is either a straddle or strangle. Adding wings to a straddle creates a butterfly and adding wings to a strangle creates a condor. Put more simply, vol trading is all about straddles/strangles (naked) or flies/condors (covered). As such, my primary trading structures are flies and condors. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 11 What Do I Aim For? With the larger account, I largely aim to hit base hits (singles, doubles, and the occasional triple) with a very high win rate. I don’t mind taking 5-10% over and over again with the very (very, very) occasional 50-100% loser on large size trades. With a smaller account, I’ll be more aggressive looking for trades that pay 100% -200% (and have opportunity for better), and I don’t mind losing a larger percent of the trades. There are a lot of ways to skin the cat, and allocation is just as important (if not more so) than strategy. Let’s take a look… © Copyright 2018 TheoTrade, LLC. All Rights Reserved 12 What Do I Aim For? Portfolio Win Rate Ave Win Ave Loss Profitable? 1 30% $300 $100 2 55% $500 $500 3 90% $100 $500 4 15% $550 $2000 5 25% $400 $100 6 5% $1000 $50 7 99% $100 $5000 8 90% $500 $4500 9 85% $100 $100 10 65% $450 $300 11 50% $1000 $1100 © Copyright 2018 TheoTrade, LLC. All Rights Reserved 13 What Do I Aim For? Portfolio Win Rate Ave Win Ave Loss Profitable? 1 30% $300 $100 Yes 2 55% $500 $500 Yes 3 90% $100 $500 Yes 4 15% $550 $2000 No 5 25% $400 $100 Yes 6 5% $1000 $50 Yes 7 99% $100 $5000 Yes 8 90% $500 $4500 No 9 85% $100 $100 Yes 10 65% $450 $300 Yes 11 50% $1000 $1100 No © Copyright 2018 TheoTrade, LLC. All Rights Reserved 14 PART 2 Knowledge primer © Copyright 2018 TheoTrade, LLC. All Rights Reserved 15 Implied Volatility Ranges For SPX trading, having “ranges” of volatility that trigger certain trading styles and choices can be helpful. Here’s the rough ranges that I use: VIX<10: Hedge your tails off AGGRESSIVELY (carry lots and lots of long vomma/vanna in the way of far OTM puts – they are extremely cheap at the moment). General bullish bias VIX 10-15: Hedge aggressively with long puts (they are still cheap), this is business as usual and where things have been living for a while. General bullish bias to keep up with market VIX 15-20: Sell premium and build structures with a more neutral bias. Hedge with verticals or condors. Start hedging upside bounce risk with vol neutral structures VIX 20-30: Sell premium more aggressively while hedging intermediate downside risk with condors/flies and verticals. General bearish bias VIX 30-50: Back up the truck on premium selling. Hedge your risk with verticals and condors. Start selling off your vol hedges. VIX >50: Head for the hills! Sell garbage premium that is insanely overpriced and hedge near the money risk with condors and verts. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 16 It’s all Greek! Having a solid grasp of risk and profitability metrics is essential to understanding your risk and earnings profit. These are measured using the “greeks,” a tool for measuring PnL changes across a variety of scenarios. There are “first order” greeks, as well as second and third order greeks. - The first order greeks affect PnL directly. - The second order greeks affect the first order greeks, - The third order greeks affect the second order greeks. © Copyright 2018 TheoTrade, LLC. All Rights Reserved 17 Delta Delta is a first-order Greek that tells us how much profit (or loss) to expect with a 1-point change in the underlying. • Delta is the ANGLE of the T+0 line. If the angle is positive (left to right, low to high, bullish trend) then delta is positive. If the angle is negative (left to right, high to low, bearish trend) then delta is negative. • 1 delta is equivalent to 1 share of stock • Delta is the only Greek than can be hedged/adjusted by buying or selling the underlying • Bullish delta is positive • Bearish delta is negative © Copyright 2018 TheoTrade, LLC. All Rights Reserved 18 Gamma Gamma is a second-order directional Greek that tells us how our DELTA will change with a 1-point move in the underlying. Gamma is the curvature of the T+0 line. Positive gamma will improve your delta in either direction Positive gamma makes your T+0 line “smile” Negative gamma will make your delta position worse in either direction Negative gamma will make your T+0 line “frown” Gamma is almost always inversely correlated to Theta © Copyright 2018 TheoTrade, LLC. All Rights Reserved 19 Theta Theta is a first order Greek that measures PnL change over 1 day of time. Note that the decay rate is estimated and NOT GUARANTEED EVEN REMOTELY. Theta is how much the time value portion (extrinsic) of an option SHOULD decay given one day of time passing. Remember, intrinsic value doesn’t decay. Options don’t tend to decay ahead of binary events. Theta inflates daily until the binary event passes.
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