LONG STRADDLES CLASS Matt Williamson © Copyright 2019 Theotrade, LLC

LONG STRADDLES CLASS Matt Williamson © Copyright 2019 TheoTrade, LLC. All Rights Reserved 2 Risk Disclosure • We Are Not Financial Advisors or a Broker/Dealer: Neither TheoTrade® nor any of its officers, employees, representatives, agents, or independent contractors are, in such capacities, licensed financial advisors, registered investment advisers, or registered broker-dealers. TheoTrade ® does not provide investment or financial advice or make investment recommendations, nor is it in the business of transacting trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation. Nothing contained in this communication constitutes a solicitation, recommendation, promotion, endorsement, or offer by TheoTrade ® of any particular security, transaction, or investment. • Securities Used as Examples: The security used in this example is used for illustrative purposes only. TheoTrade ® is not recommending that you buy or sell this security. Past performance shown in examples may not be indicative of future performance. • Return on Investment “ROI” Examples: The security used in this example is for illustrative purposes only. The calculation used to determine the return on investment “ROI” does not include the number of trades, commissions, or any other factors used to determine ROI. The ROI calculation measures the profitability of investment and, as such, there are alternate methods to calculate/express it. All information provided are for educational purposes only and does not imply, express, or guarantee future returns. Past performance shown in examples may not be indicative of future performance. • Investing Risk: Trading securities can involve high risk and the loss of any funds invested. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon, or risk tolerance. • Options Trading Risk: Options trading is generally more complex than stock trading and may not be suitable for some investors. Granting options and some other options strategies can result in the loss of more than the original amount invested. Before trading options, a person should review the document Characteristics and Risks of Standardized Options, available from your broker or any exchange on which options are traded. • No part of this presentation may be copied, recorded, or rebroadcast in any form without the prior written consent of TheoTrade ®. • No Soliciting. No Recording. No Photography. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 3

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LONG STRADDLES

Acronyms and Shorthand Cheat Sheet

• PnL – Profit and Loss (P. and L. à 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 • Stock leg – a stock transaction as part of an options trade © Copyright 2019 TheoTrade, LLC. All Rights Reserved 6

PART ONE: THE LONG STRADDLE

What the heck is a straddle?

A straddle is an options trade involving a call and a put at the same strike in the same expiration

• Long straddles involve BUYING both options

What the heck is a call option? Put option? Underlying???

This presentation is going to be fairly complex, and will assume intermediate level understanding of options mechanics.

Thankfully, we have an archive full of classes to help you understand it! Please find your way to the Options 101 section to learn more about these basics before attempting this session. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 9

Example: Long Straddle

Imagine that a company involving the rescue of baby wildlife (Xtracting Young Zebras, ticker symbol XYZ) is trading at $64.93 near the closing of the cash market.

To initiate a long straddle position, you would BUY the $65 strike call option AND put option. The cost will vary depending on time to expiration and demand for XYZ options, but let’s assume for the moment you paid $4.50 for the combined trade (call and put).

+1 $65-strike call - $2.20 +1 $65-strike put - $2.30

Example: Long Straddle

Value at expiration:

Stock Change: -$10.00 -$5.00 -$2.00 Unchanged +$2.00 +$5.00 +$10.00 $65-Strike Call $0.00 $0.00 $0.00 $0.00 $2.00 $5.00 $10.00 $65-Strike Put $10.00 $5.00 $2.00 $0.00 $0.00 $0.00 $0.00 $65-Strike Straddle $10.00 $5.00 $2.00 $0.00 $2.00 $5.00 $10.00

Example: Long Straddle

Another way to think about this trade:

1) The options market is predicting that XYZ will move +/- $4.50 by expiration. 2) By BUYING the straddle, we are predicting that XYZ will move MORE than +/- $4.50 by expiration 3) If we are right, we profit the difference between actual movement (realized volatility) and predicted movement (implied volatility) © Copyright 2019 TheoTrade, LLC. All Rights Reserved 12

The argument for long straddles:

There are some huge benefits to trading long straddles. Here are a few:

1) No directional bias (profit from up OR down moves) 2) Profit from unforeseen large broad market moves (rising tide theory) 3) Profit from unforeseen news events resulting in large sudden moves 4) Limited risk, unlimited reward 5) Able to be traded inside IRAs © Copyright 2019 TheoTrade, LLC. All Rights Reserved 13

No directional bias

Since a straddle is non-directional at outset, there’s no need to pick the direction of the stock you are trading. The straddle itself picks the direction once the move begins.

Profit from unforeseen broad market moves

If the market itself begins to crash, panic ensures that everything gets sold (or bought with parabolic buying sprees and short squeezes) together. The adages that summarizes these:

Bullish: Rising tides lift all boats. Bearish: In a crisis, correlation goes to one.

Profit from unforeseen news events

If an unknown news event affects a stock on which you’re holding a long straddle, that’s effectively a jackpot. The stock makes a huge move, often in the pre-market or after the close, and you realize the gains on the move.

Very important to note that this must be an unforeseen news event. The options market prices in potential moves from known events (earnings, FDA announcements, etc.) © Copyright 2019 TheoTrade, LLC. All Rights Reserved 16

Limited Risk, Unlimited Reward

Long Straddles are a fixed and known risk trade. The total debit paid for the straddle is the maximum possible loss for the trade. The potential reward is unlimited to the upside, and limited to the downside since the company can only go to zero (in such cases, a straddle would produce many thousands of percentage points in return on risk, so the reward to the downside, while technically limited, is, in practice, “unlimited.”) © Copyright 2019 TheoTrade, LLC. All Rights Reserved 17

The perfect IRA trade?

Long straddles are allowed in IRA accounts, allowing for explosive growth in accounts that are typically restrictive with what types of trades are allowed.

PART TWO: VOL AND YOU

What are we actually trading here?

Volatility: that thing you don’t pay enough attention to

“An options trader that doesn’t pay attention to volatility is like a bird who doesn’t pay attention to wind.” -me

Since volatility (or the lack thereof) is a HUUUUGE determiner of how much options cost, and we’re buying options, let’s understand what it is, shall we?

There are two types… © Copyright 2019 TheoTrade, LLC. All Rights Reserved 21 Historical (AKA Realized) Volatility: What (already) happened Historical (AKA realized) volatility is a measurement of what happened. It’s typically expressed annualized so that we can make useful comparisons, and to make it more confusing.

Historical volatility will be expressed in a percentage format, like this:

25%

Translation: Based on the previous ‘x’ period, the annualized standard deviation of returns is 25% © Copyright 2019 TheoTrade, LLC. All Rights Reserved 22 Implied Volatility: What we (the options market) think will happen Implied (AKA forward) volatility is what the current options market is predicting will happen. It’s also expressed annualized so that we can make useful comparisons, and to make it more confusing.

Implied volatility will also be expressed in a percentage format, like this:

25%

Translation: Over the upcoming ‘x’ period (x can be whatever period you want to use), the projected annualized standard deviation of returns will be 25%. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 23

Winning the long straddle game:

Assuming no adjustments, we “win” a straddle trade if the implied volatility, which is the amount of assumed movement we are buying, is EXCEEDED by the ACTUAL movement (historical volatility) of the underlying.

In other words, if implied volatility is UNDERPRICED, and we buy it, we win.

PART THREE: TOOLS

Implied Vol vs. Historical Vol:

Looking at a historical plot of implied volatility vs. historical volatility will give a sense of how often IV is underpriced vs overpriced.

However, because IV looks forward and HV looks backward, to line them up, we must offset one. We can’t push today’s HV forward twenty periods since we don’t know what happened yet. We can push today’s IV forward twenty periods though…

We want to view implied volatility twenty periods ago (what did the market think was going to happen over the next twenty periods, twenty periods ago?) vs historical volatility today using a lookback period of 20 periods (what actually happened over those twenty periods?) © Copyright 2019 TheoTrade, LLC. All Rights Reserved 26

Implied Vol vs. Historical Vol:

Voila! http://tos.mx/2ckDj1 http://tos.mx/UZFPui w/ straddle edge

IV Percentile:

Ideally, we want to buy premium when demand is low(est) since that would result in the lowest price, so it’s helpful to know where IV (options prices) is relative to where it’s been. Enter IV Percentile. A low value indicates that option prices (IV) is low relative to its range over the prior year, the proverbial green light to buy.

I’ve also plotted the IV floor and ceiling over the previous year to give context on range. If the floor holds, I’ve also plotted risk if IV/option demand drops after buying the straddle and finds its previous floor. All helpful metrics in evaluating risk and trade suitability. http://tos.mx/WZIBcP © Copyright 2019 TheoTrade, LLC. All Rights Reserved 28

PART TWO: CRITERIA AND ENTRIES

SECTION 1: CRITERIA

What tickers?

Any stock with:

• Reasonable option volume (>1k per day - avoid roach motels)

• Reasonable stock spreads (0.01% spread width (e.g. a penny wide spread on a $100 stock, or a $.10 spread on a $1,000 stock)

• A price over $x.xx (I like over $100, you might like over $30)

Here’s a watchlist to help get you started: http://tos.mx/l0KeH2

Market Volatility Allocation Guide

Market volatility levels (use VIX):

• 9 - 12%: LOAD THE BOAT! • 12 - 15%: All signs go • 15 - 20%: Cut back allocation • 20%+: Do not enter

Stock Volatility Criteria:

We want a stock that has:

• Low vega risk, defined as “as near as possible to its 1-year IV low, or IV ‘floor’” (I prefer to have to perform LESS THAN 10 scalps per month to cover my vega risk)

• Low theta cost relative to gamma benefit, defined as “One half of daily ATR results in profit greater than or equal to one day of theta burn”

• Low IV “Rank” (bottom quartile of trailing 52 week range)

• An extended Bollinger band contraction, end-of-a-price-wedge, or near support or resistance is a nice bonus criteria.

Use the excel tool to help you find candidates: https://bit.ly/2kCzl0L

Other stock criteria

Avoid upcoming binary events!

• No earnings!

• No FDA announcements!

• No mergers or acquisitions!

What expirations?

Market volatility levels (use VIX):

What strike?

It’s a straddle, people. Use the AT THE MONEY strike.

“But what about ______?” “No. Use the ATM strike.”

“My friend Paul watches CNBC all the time. He said I should ______” “No. Use the ATM strike.”

“I read about gamma and I was thinking that I could ______” “No. Use the ATM strike.”

“If I used way OTM strikes, I could maximize my second order greeks and really ratchet up the…” “No. Use the ATM strike.”

Calculate your risk

Your approximate daily risk is:

“…but Matt, a straddle is a fixed risk trade in which the maximum loss possible is the debit paid.” “Thank you! Moving on... ☺”

Your approximate daily risk is:

Vol risk: Current implied volatility level MINUS implied volatility LOW over the previous 52 week period multiplied by your position vega. ((IV – IV Floor)* vega)

Theta risk: Today’s daily theta

1 day risk = (Vol risk + Theta Risk)

SECTION 2: ENTRY

Pre-Entry Checklist q Check VIX level for allocation q Underlying meets IV Rank requirements (bottom quartile) q Vega risk requirements met (less than 10 scalps to cover vega risk) q Theta risk requirements met (less than 1 scalp to cover daily theta burn) q Check allocation requirements and capital requirements to hedge q Calculate perceived 1 day risk q Know the ATR and hedge points © Copyright 2019 TheoTrade, LLC. All Rights Reserved 39

Step 1: Build Your Order Ticket

Build the order ticket by adding 1 long call option and 1 long put option in the same order as a spread (a straddle spread, specifically).

Example:

+1 $65-strike call - $2.20 +1 $65-strike put - $2.30

Step 2: Check your pricing

The order should be a DEBIT order (we are buying both options) and the total price should be equal to the MID prices of both options. Some brokers will default to the NATURAL (ASK/OFFER) price for both options. DON’T PAY THAT!!!

Example:

+1 $65-strike call - $2.15 x $2.25 MID - $2.20 +1 $65-strike put - $2.25 x $2.35 MID - $2.30

Step 3: Adjust quantity to your risk tolerance

Add contracts of both the calls and puts in equal amounts until your 1 day risk tolerance is reached.

Allocation calculation:

Account size / (Perceived 1-day risk/desired allocation)

Example 1:

Desired allocation: 1% of account 1-day perceived risk for 1 straddle: $565 Account size: $65,000

Step 3: Adjust quantity to your risk tolerance

Allocation calculation: Account size / (Perceived 1-day risk/desired allocation)

Example 2:

Desired allocation: 5% of account 1-day perceived risk for 1 straddle: $120 Account size: $14,000

Allocation: $14,000 / ($120/.05) $14,000 / $2,400 5.833333333333333333333333333333333333333333333333333333333333 5 straddles, 6 if you’re feelin’ lucky! © Copyright 2019 TheoTrade, LLC. All Rights Reserved 43

Step 4: Check your deltas and make tweaks

Model the trade and check your deltas.

Flat delta: do nothing, move to step 5

Short delta: add an underlying long stock position to the order ticket. You can use a 1st trgs all or 1st trgs sequence order for this if you want your broker to WAIT until the entire straddle is filled before sending the underlying stock order though. Keep in mind this will have price movement risks unless you want to use a market order for the shares.

Long delta: add an underlying SHORT stock position to the order ticket. If you are trading in an IRA account, this is NOT possible, and you’ll need to use additional put(s) to balance deltas to zero, or risk movement in the wrong direction at the outset of the trade. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 44

Step 5: Enter and work the order!

Never need the trade more than the trade needs you. Put your order in and walk away, but be mindful of partial fills, as those can be a problem. If you get a partial fill, you may want to increase your price a bit to force the rest of the fill. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 45

Step 6: Track your position

Once you’ve entered the trade, you’re waiting for one of two things to happen:

1) Vol increase 2) Enough price movement to execute a delta rebalance (i.e. a scalp)

You’ll need to watch price and have an alert system set up to tell you when it’s time to scalp or when it’s time to exit. We will cover all the management in part three. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 46

PART THREE: GAMMA SCALPING & EXITS

SECTION 1: ALL ABOUT GAMMA SCALPING

Greeks Review - Delta

• Delta measures directional exposure • Specifically, how much will be made or lost on a one-point move UP in the underlying

• Delta is the snapshot angle of the T+0 line • Bull-trend-angle (bottom left to top right) = bullish (positive) delta • Bear-trend angle (top left to bottom right) = bearish (negative) delta © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 49

Greeks Review - Gamma

• Gamma measures momentum of directional exposure • Specifically, how much our delta gains or losses will accelerate on a one-point move UP in the underlying

• Gamma is the snapshot curvature of the T+0 line • Happy-face curvature = good (positive/helpful) gamma • Sad-face curvature = bad (negative/harmful) gamma © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 50

Greeks Review - Theta

• Theta measures theoretical one-day-position decay • Specifically, how much our position will profit (or lose) given a one-day passage of time

• Theta and gamma are joined at the hip! • Good gamma = negative theta • Bad gamma = positive theta • While this is not ALWAYS true, it’s mostly true and a good rule of thumb to remember © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 51

Greeks Review - Vega

• Vega measures theoretical position value change given a change in option supply and demand picture • Remember, option prices are driven by supply and demand, nothing else! If demand increases on one strike, all other strikes must compensate, lest arbitrage opportunities arise.

• Vega can be thought of as a proxy for exposure to option demand • Positive vega = long demand (wants more net buying/higher prices) • Negative vega = long supply (wants more net selling/lower prices) © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 52

Straddle Risk Profile (at inception)

Delta: 0 (no directional bias) Gamma: + (directional bias forms via accumulating favorable delta in either direction) Theta: - (we pay daily to hold the position) Vega: + (we are long demand, i.e. we want more option buying)

Looking above, we aren’t going to make any money from theta (we’re losing money daily) and we aren’t going to make any money from delta (initially), so our profit drivers are:

Vega Gamma

Gamma at work

Underlying (-$4.00) (-$3.00) (-$2.00) (-$1.00) 0% +$1.00 +$2.00 +$3.00 +$4.00 Gamma 11.00 12.00 13.00 14.00 15.00 14.00 13.00 12.00 11.00 Delta -54.00 -42.00 -29.00 -15.00 0 15.00 29.00 42.00 54.00 © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 54

Gamma at work

Underlying (-$4.00) (-$3.00) (-$2.00) (-$1.00) 0% +$1.00 +$2.00 +$3.00 +$4.00 Gamma 11.00 12.00 13.00 14.00 15.00 14.00 13.00 12.00 11.00 Delta -54.00 -42.00 -29.00 -15.00 0 15.00 29.00 42.00 54.00 PnL $86.00 $44.00 $15.00 $0.00 $0.00 $0.00 $15.00 $44.00 $86.00 © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 55

Gamma at work

• As you can see, gamma causes an accumulation of delta, which yields two things:

1. Accumulation of profit in a directional move 2. Accumulation of directional (reversal) risk in a directional move

In other words, it creates exponential profits in a large move, but the more accumulation we see in profit, the more reversal risk we take on. So we will need to deal with that risk. Gamma scalping is the art of negating that constantly developing risk while locking in the accumulated profit. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 56

So what is “gamma scalping”

• Simply put, we are going to “neutralize” our delta risk at pre-defined levels by buying or selling deltas to get our position back to net zero deltas. This neutralizes the reversal risk of the position. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 57

Gamma scalping example – move #1

We get a $3.00 move down, resulting in a new delta of -42.00, a new gamma of +12.00, and PnL of + $44.00

Gamma scalping example – move #2

Underlying (-$4.00) (-$3.00) (-$2.00) (-$1.00) 0% +$1.00 +$2.00 +$3.00 +$4.00 Gamma 11.00 12.00 13.00 14.00 15.00 14.00 13.00 12.00 11.00 Delta -54.00 -42.00 -29.00 -15.00 0.00 15.00 29.00 42.00 54.00 Straddle PnL $86.00 $44.00 $15.00 $0.00 $0.00 $0.00 $15.00 $44.00 $86.00 Stock PnL $0.00 $42.00 $84.00 $126.00 Stock Delta +42.00 +42.00 +42.00 +42.00 Position Delta 0.00 +13.00 +27.00 +42.00

We get a $3.00 move back up, erasing all profits and Greek changes from our options trade (the straddle). We are now once again flat delta, +15.00 gamma, and $0.00 PnL on the trade less any theta or vol changes.

However, because we bought stock, we profited $126.00 on the move back up. We would now SELL that stock to neutralize our delta once more, realizing the gain. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 59

Gamma scalping example – move #3

Underlying (-$4.00) (-$3.00) (-$2.00) (-$1.00) 0% +$1.00 +$2.00 +$3.00 +$4.00 Gamma 11.00 12.00 13.00 14.00 15.00 14.00 13.00 12.00 11.00 Delta -54.00 -42.00 -29.00 -15.00 0.00 15.00 29.00 42.00 54.00 Straddle PnL $86.00 $44.00 $15.00 $0.00 $0.00 $0.00 $15.00 $44.00 $86.00 Stock PnL 0.00 0.00 0.00 0.00 Stock Delta 0.00 0.00 0.00 0.00 Position Delta 0.00 15.00 29.00 42.00

We get a $3.00 move higher again, netting us $44.00 on the straddle and a new delta of +42.00 and a new gamma of +12.00. We SELL 42 shares to neutralize our delta. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 60

Gamma scalping example – move #4

Underlying (-$4.00) (-$3.00) (-$2.00) (-$1.00) 0% +$1.00 +$2.00 +$3.00 +$4.00 Gamma 11.00 12.00 13.00 14.00 15.00 14.00 13.00 12.00 11.00 Delta -54.00 -42.00 -29.00 -15.00 0.00 15.00 29.00 42.00 54.00 Straddle PnL $86.00 $44.00 $15.00 $0.00 $0.00 $0.00 $15.00 $44.00 $86.00 Stock PnL $126.00 $84.00 $42.00 0.00 Stock Delta -42.00 -42.00 -42.00 -42.00 Position Delta -42.00 -27.00 -13.00 0.00

We get a $3.00 move back DOWN, erasing all profits and Greek changes from our options trade (the straddle). We are now once again flat delta, +15.00 gamma, and $0.00 PnL on the trade less any theta or vol changes.

However, because we SOLD stock, we profited $126.00 on the move back down. We would now BUY back to cover that stock to neutralize our delta once more, realizing the gain for a total realized gain of $252.00. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 61

Gamma scalping example – move #5

Underlying 0% +$1.00 +$2.00 +$3.00 +$4.00 +$5.00 +$6.00 +$7.00 +$8.00 Gamma 15.00 14.00 13.00 12.00 11.00 10.00 9.00 8.00 7.00 Delta 0.00 15.00 29.00 42.00 54.00 65.00 75.00 84.00 92.00 Straddle PnL $0.00 $0.00 $15.00 $44.00 $86.00 $140.00 $205.00 $280.00 $364.00 Stock PnL 0.00 Stock Delta -42.00 Position Delta 0.00

Gamma scalping example – move #6

We get another $3.00 move higher again, netting us another $161.00 on the straddle and a new straddle delta of +75.00 and a new straddle gamma of +9.00. Awesome! But what about our short stock position?

Oh, it’s getting killed. We lost $126.00 on the way up. Hmmmm, we’re still up money though (+$35), because our positive gamma ensures that we are accumulating delta along the way. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 63

SECTION 2: THE SYSTEM

The thing NO one will tell you

• Everyone will tell you what gamma scalping is and how it works.

Price level vs. % level

• Some people use price levels. Here are some ideas: • Scalp at resistance and support when rangebound • Scalp every x points

The importance of volatility dependence

• The thing is, your system MUST be volatility dependent, since we are trading volatility. You can’t scalp every 10 points on the SPX and every 10 points on the XLU. They aren’t the same underlying and don’t move the same amount.

• You can’t scalp every 2% on a biotech and every 2% on the XLU for the same reason. 2% on the biotech isn’t going to happen with the same frequency as 2% on the XLU. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 67

2 ways to approach scalp triggers

1. Delta: delta is vol dependent, though it changes with IV levels • Example: scalp when delta of straddle option changes by x%

2. Price movement tied to volatility study (Bollinger bands, Keltner Channels, ATR, etc.) • Example: scalp when price touches upper/lower Bollinger band, then again when it touches middle Bollinger band. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 68

My method: ATR

I scalp every time price moves ½ ATR. That should net 2+ price scalps on most days.

Let’s examine further…

Example #1: Trend Up Day

Starting Price

Scalp #1

Example #2: Trend Down Day

Starting Price

½ ATR DOWN

Scalp #1

½ ATR DOWN

Example #3: Range Day

Starting Price

Scalp #1

Example #4: Range Day

Starting Price

Scalp #1

Example #5: Choppy Range Day

SECTION 3: THE EXIT

2 options for exits

There are two main criteria for exits:

1. Volatility Level • Your volatility target was reached • Your lower volatility stop was breached

2. PnL Level • Your PnL target was reached (use a %) • Your PnL loss was reached (again, use a %)

Volatility exit

We are looking for a reversion to the volatility norm. An example would be a move from current IV level to the 200 day moving average of IV. That would be a valid and clear volatility signal. IV Floor is the volatility stop loss target. If IV falls below the 52- week low of IV, exit (or alternately, if you’ve decided ahead of time to take a scaled entry approach, add size) © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 77

PnL exit

Like any other trade, you can use PnL % targets as exit. Example:

Exit at 10% profit or 10% loss, whichever comes first.

Keep in mind this approach will work ONLY if your probabilities are known or are at least accurately forecasted to establish positive expectancy. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 78

Up next!

In Session 4, we will cover portfolio management and some additional allocation examples and discuss blending this into a short vol/neutral portfolio. © Copyright 2019 TheoTrade, LLC. All Rights Reserved 79

PART FOUR: PORTFOLIO MANAGEMENT

SECTION 1: ASSESSING VOLATILITY RISK

Do you know where your risk lives?

We all have portfolios consisting of a variety of different assets:

• Stocks • Options • Futures • Metals • Real Estate • Collectibles • Etc. etc. etc.

Regardless of your particular mix of assets, there is risk inherent in them ALL (yes, including cash stashed in the mattress). © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 82

How to look at your entire trading portfolio

To view comprehensive risk, we must equate all your positions to one commonality. Enter beta weighting.

Q: “Matt, what’s beta?” A: Beta is a measure of volatility correlation.

More simply, beta tells us how much a given position should change given a change in a defined broad market. A beta of 1 would indicate perfect correlation. If the market moves 1% and your portfolio beta is 1, you should see a 1% increase in your position.

The easy way

Use your trading platform. Here’s where it’s located in thinkorswim:

The more difficult way:

If your platform doesn’t support beta-weighting, you’ll need to calculate your own beta- weighted deltas. Fun! Here’s how you do it:

(Stock Price * Stock Beta * Stock Position Delta) * (1 / Beta Symbol Price)

Example:

Long 100 shares of AAPL beta-weighted to SPY

(208.74 * 1.223 * 100) * (1 / 292.45) (25,528.90) * .0034193879 100 shares of AAPL = 87.29 shares of SPY

Make sure you do it for everything!

A 50 delta option = 50 shares of the underlying 100 shares of XYZ = 100 deltas of XYZ

You need to see the WHOLE portfolio, so make sure you beta-weight EVERYTHING together!

Need a tool? OK!

Excel (download) – https://bit.ly/30TnH1o (Links to thinkorswim for data) Google Sheets – https://bit.ly/2MPk9cW (Links to Google Finance for data [no control over beta symbol, not all symbols supported])

Same portfolio in thinkorswim:

So where is the risk? In both cases, though the delta values are (alarmingly) different, the risk is bearish delta. If the broad market rises, we will be losing some amount of money on the way up owing to the bearish tilt on the portfolio.

Find the risk: Example 1

Beta-weighted to SPX

Find the risk: Example 2

Beta-weighted to SPX

Find the risk: Example 3

Beta-weighted to SPX

Find the risk: Example 4

Beta-weighted to SPX

Find the risk: Example 5

Beta-weighted to SPX

VIX Sub 12 – no risk anywhere

• Buy calls to play upside (trend following) • Buy puts to play downside (contrarian)

VIX 12 – 15: Low Risk

• Buy calls (or wide verticals) to play upside • Buy puts (or wide verticals) to play downside

• Opportunistically add longer-dated long volatility exposure on the lower end of this range (12 - 13.5), scalp theta risk © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 96

VIX 15 – 20: Moderate Risk

• Play upside with call spreads or call butterflies or condors • Play downside with put spreads and wing spreads

• Vol neutral here. You need to be opportunistically selecting overvalued short vol and selling it, and finding undervalued long vol and buying it. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 97

VIX 20 – 25: Elevated Risk

• Play upside with flies and condors • Play downside with verticals, flies, and condors

• Lean short volatility at this point. Index premium and skew is FINALLY attractive to sell. Be ready to hedge it if you’re going to sell it though. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 98

VIX 25 – 30: High Risk

• Start buying call calendars if heavy backwardation in force • Upside butterflies still viable, though big moves will blow through them • Downside naked premium can be sold to finance long spreads • Upside can be played with naked short puts (limited reward though)

VIX 30 – 40: Very high risk

• If looking for a bounce, narrow call backspreads work well due to the aggressive overshoot to the upside • DO NOT BUY OUTRIGHT CALLS! • Selling puts can be a nice way to play upside • If playing downside, ultra-wide spreads work well and are priced well

VIX 40 – 50: Catastrophic risk

• I prefer to start dumping risk at this level rather than placing new trades, but if you must trade, trade spreads in either direction. And be prepared to suffer major, major slippage.

• Your short vol portfolio isn’t feeling too smart now, but if you can stomach it, add more. © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 101

VIX 50+: Catastophic risk is being REALIZED

• Go to cash and buy companies that don’t suck. Forget options. Everything is on FIRE sale. Want to own AAPL for book value? There it is. Go get it.

• If you’re crazy enough to trade volatility here, do it on the short side, and prepare for momentary spikes to 80, and for my sake, allocate SMALL! © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 102

Balance the portfolio exercise Let’s assume we have a portfolio and we want to balance that portfolio. What would you add to each of these portfolios to achieve your goals? © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 103

Portfolio 1 VIX: 25

Delta - +192.54 Gamma - -2.54 Theta - +1815.45 Vega - -6548.15

Portfolio 1b VIX: 10

Delta - +192.54 Gamma - -2.54 Theta - +1815.45 Vega - -6548.15

Same portfolio, different VIX/market environment. Where is the risk? What do you need to do? © Copyright 2019 TheoTrade, LLC. All Rights Reserved © Copyright 2019 TheoTrade, LLC. All Rights Reserved 105

Portfolio 2 VIX: 30

Delta - -14.98 Gamma - +12.54 Theta - -452.84 Vega - +2568.91

Portfolio 3 VIX: 20

Delta - -14.98 Gamma - -25.54 Theta - +4452.84 Vega - -8968.91

Portfolio 4 VIX: 40

Delta - +546.98 Gamma - -0.54 Theta - +35.44 Vega - -109.91

Where is the risk? What do you need to do?