“Dead Options-Trader Society?” Taking an introspective look at the requirements for selecting good underlying assets for my Vertical Bull Put Credit Option Spreads and how to go about finding them.

I stand upon my desk to remind myself
that we must constantly look at things
in a different way.

– John Keating (Movie: Dead Poets Society)

Commentary

Success in life, poetry, or even Options Trading is not about what I have been given – but what to do with what I have. It’s not about fairness, what I am due, or what I am denied – but changing the circumstance to improve my lot. It is not about what I see – but how I see.

Maybe I should start “Dead Options-Trader Society.”

This week’s journal entry is about taking a critical look at why I select the underlying assets I use to craft my Options Spreads. I want to review this, not so much in a new way, but in a deliberate way.

Looking at Things in a Different Way

As a public exchange of assets, with hundreds of thousands of participants, the dynamics of the Stock Markets make it challenging to navigate. So as a prerequisite to picking the right security to use as an underlying asset for my Options Spreads, I first need to take a close look at the arena I want to work in, and I must have coherent trading objectives.

Intrinsic Nature of the Stock Markets

O Captain, My Captain!

(Movie: Dead Poet Society)

One: The United States economic system is built upon the belief that “Free Enterprise” is the best way to build wealth. And the best way to build wealth is to start private businesses. And the best way for private businesses to raise capital is to sell stocks. So corporations around the world want their stocks to increase in value.

Two: The stock markets are comprised of a lot of money from a lot of people. And the only reason why these “lots of people” buy and sell stocks is to make lots more money. So there is a lot of effort, by a lot of people, to make the stock markets go up. (That’s a lot of lots!)

Three: US Government receives significant revenue from those who participate in the Stock Markets by taxing our capital gains and brokerage transactions. As a share of all Federal Revenues through 2009, capital gains taxes (both individual and corporations) averaged about 7.4 percent. By the end of 2020, that percentage could go as high as 15%. So laws are written on a bipartisan basis to ensure the markets continue to rise and taxes collected.

My Arena

There is a massive effort towards building and maintaining a Bull Market. Congress will write laws to facilitate growth, Corporations are required by law to increase in value, and thousands of participates are buying low and selling high. So if there were an innate nature to the Stock Market, that nature would be to increase in value.

Therefore, I will focus on the broader Market’s Index funds for my Vertical Bull But Credit Spreads.

My Trading Objectives

Sucking the marrow out of life
doesn’t mean choking on the bone.

-John Keating (Movie: Dead Poets Society)

Before I can pick the right securities, I must know my investment and trading objectives. By doing so, I can clearly define my goals, which then helps me choose the proper investment strategies aligned with those objectives. 

Objective 1: Options Trading for a Steady Income

As the motto and Mission Statement for this blog insinuates, I want to see if I can make a steady income from trading Options.

My goal is NOT to make homerun Options transactions, brag about my investment sagacity on Twitter, then later go dark because my cockiness finally blew up my account, leaving me deeply in debt. But my goal IS to have a consistent and positive cash flow where I can make a predictable income every month – every year.

Objective 2: Gain an Thorough Understanding of the Dynamics of Options Trading

A naïve trader can lose a lot of money trading options. Unlike buying or selling individual stocks, Options Contracts require a lot more knowledge and a commitment to the ebb and flow of Options dynamics.

I need to be hyper-aware of the daily movements of the underlying assets of the Spreads that I am trading. I need to have a thorough knowledge of the mechanics of Options pricing. And I need to be sensitive to the Geopolitical events around the world that will whimsically influence my open positions.

Objective 3: Pick an Arena, Pick a Limited Set of Securities and Stick To It

Different securities in different sectors will have different dynamics. As I learn this trade, I need to focus on one sector and no more than 4 to 6 securities within that sector. Any more will require too much time for weekly research and monitoring.

How To Achieve These Objectives:

1. The “Steady Income” requirement will be achieved by automatically transferring $300 out of my trading account on the last Friday of every month. If Options Trades by Damocles was a business, then this $300 would be my commission (my steady income). The success or failure of my Options effort will be determined at the end of the year as my trading account will have either more or less of the original investment.
   
   Everything is scalable. A $3,600 yearly income ($300/mon * 12) from a $16,000 is a 22.5% ROI. In future years, if I want to increase my monthly take-home, I would my investment strategy the same but increase my initial investment.

2. Throughout the past couple of years, I gravitated towards the arena of the Broader Markets Indexes as my preferred arena. I could have easily focused on the Retail Sector and learn the behavior of Wal-Mart, Amazon, and the likes. Or towards the Financial Sector or anything else. Each one of these will have different dynamics.

3. Keep abreast of the financial and political news every day. I have found that CNBC, Fox Business, and Yahoo Finance great sources of information. Each has different political spins and different priorities of today’s news.

4. Actively participate in the buying/selling of Options contracts daily. Frequently, I will ‘stage’ multiple positions one day and then execute one of those the next after seeing how the Markets moved. My trading strategy includes opening at least two new Options positions each week.

5. Focus on Spreads that have the best chance of winning.
   • Understand the trajectory and tendency of the Markets and Trade the Trend.
   • Viscerally understand the probability theory of the Law of Large Numbers (LLN) and what it means.
   • Focus primarily on Bull Market Spreads with a high (80%) probability of expiring worthless. (This Option strategy wins when the market moves bullish or side-ways. It can also win in a market adjustment if it is not too extreme.)
   • The Short-Strikes of my spreads should be at least one Standard Deviation below the underlying’s opening price. Doing so will automatically include Implied Volatility (IV) of the asset when picking my Spread’s Short-Strike. The post “Entry Rules for Vertical Bull Put Credit Spreads” goes into detail on how to calculate SD

6. Document lessons, news, and trading activity as much as possible. The act of writing helps transform what I think I know into actionable knowledge. Keeping a Trading Journal is critical to learning!

Picking the Right Stock for My Option Spreads

There’s a time for daring and there’s a time for caution,
and a wise man understands which is called for.“

-John Keating (Movie: Dead Poets Society)

The underlying security I want to use for my options will be either a stock or an ETF. But, they can also be bonds, currency, or other commodities – if I wish to get that complicated.

The  Components of a Good Underlying

• Stocks vs. ETFs? Corporate Stocks will have a higher risk of an abrupt downturn. A bad Quarterly Report, SEC investigation, a civil lawsuit, a new federal law are amongst many actions that can turn a bull Stock into a long-term bear. On the other hand, ETFs are a group of Stocks (like a Mutual Fund). Lousy company news from one included stock will be muted. Therefore, ETFs tend to thrash less, be more predictable, and safer.
  
  But adversely, ETFs will have aggregately lower volatility than a single Stock. With lower IV, there will be lower premiums available. I will not make as much from an ETF Spread as I would from a similarly constructed Stock Spread.
  
  Since I would rather have many lower-income wins over a few big income wins, I pick ETFs over Stocks.

• High volume ETFs (liquidity): If I focus on ETFs that typically have over 30 million trades during an average day, then I can expect a quick buy and a quick sell when I ask for it. High volume ETFs will have a smaller Bid/Ask spread than low volume ETFs.

• Familiar ETFs: I want to choose ETFs that I would include in my Buy and Hold portfolio. ETFs that I am confident will increase in value over the near term are the ones I want to own as a long-term investment – and are well suited for my Bull Put Spreads.

• ETFs with High IV: As mention above, the higher volatility, the higher the potential premiums I can collect. But even better, high volatility combined with high volume will have an Options Chain that is deep. Since Vertical Bull Put Credit Spead makes its money from strike premiums (and not from the asset’s price), the wider-strike spread will provide greater income.

• Choose Medium to Higher Priced ETFs: Medium or higher priced ETFs can offer a good range of movement. Higher priced ETFs tend to carry a higher premium opportunity and deeper Option Chain.

My Favorite Assets For My Favorite Spreads

No matter what anybody tells you,
words and ideas can change the world.

– John Keating (Movie: Dead Poets Society)

Below are four of my favorite ETFs. I now use these exclusively as underlying assets for my Spreads.

(Note: I write these Journal Entries for the exclusive purpose to help me solidify what I ‘think I know’ into actionable understanding. But I also know that many people read these entries. So please read my disclaimer at the bottom of this post.)

Carpe diem!
(seize the day!)

Other Posts from OptionsTradesByDamocles

This Week’s Market Sentiment

(As of 04/26/2021)

In this section, I review five indicators: VIX, Put/Call Ratio, S&P 500, Consumer Sentiment Index, and Geopolitical events that could affect the market’s direction. I will use these indicators to help guide my trading decisions for this week.

This Market Sentiment Section is typically completed by midday Monday morning. By the time this journal is published, it will be a week old.

VIX: Broad Market Volatility

The VIX is an emotion-gauge for the general investing population. It is thought to be driven by the Marketeers’ current level of greed or fear. As a one-month forward-looking volatility matrix, it is not designed to tell us which direction the market will be going, but more of how fast it can get there.

A VIX of 15% is assumed to be a market at rest. But since the intrinsic nature of the Stock Market is to move up, the markets with a VIX closer to 15% or below will have an innate tendency to rise.

The 1-month Regression Channel for the VIX took a little pump north, but I do not think that will derail the general market volatility improvements.

The VIX ended last week at 17.3%, higher than the week before 16.3%. This bump happed just as the Biden Administration floated the trial balloon of a Capital Gains tax rate nearing 50%. Marketeers did not like that and made the feels noted.

The current VIX (17.33%) is equal to the 9-Day SMA but the 9-Day SMA remains above the 50-Day. So there is a steady trend towards lower volatility.

The VIX continues to hover above 15%, which in itself is waving the jitters’ flag. And the late week Capital Gain scare also boosted concerns. So, this week’s DEFCON (Options Trading Readiness Signal) will be initially set at 4. Let’s see if the other indicators will change this level.

DEFCON = 4

Put/Call Ratio:

Put Options are frequently used as protections against existing investments falling. When the ratio between Put Options bought versus Call Options bought is above 1, then this is an indicator that the Marketeers are buying insurance to what they may see as declining Markets. Conversely, when the Put/Call Ratio falls below 1, then there is a general sense that the broader Markets will increase, and more investors are buying more than selling.

The ratio jump from .47 the week before to .55 by the end of last week compliments the jump in the VIX.

The 9-Day SMA is now above the 50-Day SMA. So the short-term trend is moving more to the jitters side.

There is nothing here that will help the DEFCON level, so I’m going to leave it at a solid 4.

Maintain DEFCON = 4

Consumer Sentiment Index (CSI):

(ycharts.com) This Consumer Sentiment Index (CSI), as provided by the University of Michigan. This indicator tracks US consumer sentiment based on surveys on random samples of US households.

A low rating is a general dissatisfaction with our current management of U.S. economic policies. This dissatisfaction will imply that something has to change. A high satisfaction rating suggests approval of the current policy management and implies market stability.

This week’s CSI chart has not been updated since last week. It remains at 86.50.

I changed the chart to 3-year to provide perspective at what the CSI level was prior to the COVID-Lockdowns.

It remains below 90, so I can’t say “things are peachy.” But the continued improvement in Consumer Sentiment is a good sign that the economy is ramping up.

Maintain DEFCON = 4

Market Indexes:

DOW (DJX) = 34,043 – Down 0.4% from 34,201 last week. (4 week deviation: 376 down from 500 last week)
S&P 500 (SPX) = 4,180 – Down 0.1% from 4,185 last week. (4 week deviation: 74.3 down from 93.8 week)

The S&P 500 is a stock market index that tracks the 500 largest companies in the U.S. This index represents about 80% of all the capitalization for the country. The S&P is widely considered the best indicator of how all the U.S. markets are performing.

Market Thrashing

4-Week Thrashing of DJX = +/- 376 points or 1.1% of the market’s volume is up from 1.5% last week.
4-Week Thrashing of SPX = +/- 74.3 points or 1.8% of the market’s volume is up from 2.2% last week.

The Indexes thrashing in the 1.x% is indicating a steady-hand market. And since the S&P 500 and DOW’s trend trajectory is bullish, there is no reason to believe that will change. So with the VIX being near 15%, the P/C Ratio above 0.5, and the calming market is bullish, I will not change the DEFCON.

Maintain DEFCON = 4

Geopolitical Tree-Shakers (GTS):

One way to look at the GTSs is like a lit fuse to a bomb. The fuse can be fast or slow, and the bomb can easily be a dud. But I need to watch this closely as an indicator. The GTS can significantly disrupt all the other indicators at the drop of a hat.

The GTS For This Week

• A $2T Federal Infrastructure/Tax bill is being negotiated – expect lots of pork
• Another $1.8T “Family Rescue” bill to be unveiled during State-of-the-Union
• Rising interest/inflation rates will be a continued background pressure for some time
• DC Statehood or Senate Packing?
• Federal Reserve to start unwinding asset purchasing
• Markets will rattle as specifics on tax increases are being leaked
• Political, racial, judicial, and general sociological discontent is rising

With a razor-thin majority in Congress, the massive new spending and major tax increases proposed by the Democrats do not have a prayer of passing this year or next. To pass these mammoth bills would require the Senate to abolish the Filibuster Rule AND convert every conservatives/moderate Democrat to left-wing ideologues. A herculean task with no Hercules to do it.

But even so… just throwing such extreme measures out to the Social Mob has caused the Marketeers to clinch their respective sphincters.

Maintain DEFCON = 4

My sentiment for this coming week:

The indicators (VIX, CSI, P/C Ratio, and Market Trends) continue to show a happy group of Marketeers for this coming week. But geopolitical events will always be a significant influencer for my Vertical Bull Put Credit Spreads. Regardless of whether the events are real or fake, hyper-political news can send the markets into a tizzy at any time.

I feel that there will still be a couple of weeks aggressive growth.

VIX, GTS, P/C Ratio and current Markets are strong motivators to maintain DEFCON 4.

Trading Readiness Level

DEFCON = 4

This week, I will focus on:

• Two spreads (both totaling < $2.5K risk) as the Markets see fit.
• Spread term of 8-weeks or less.
• Probability of OTM > 80%

Profit and Loss Statement

(As of 04/30/2021)

Balance Sheet

	Year 2021	Month Apr	Week #17
Beginning Account Balance	$16,000.00	$17,057.20	$17,549.94
Deposits (Div. & Int.)	$0.50	$0.00	$0.00
Withdraws (paycheck)	-$1,200.00	-$300.00	-$300.00
Premiums on Open	$2,928.01	$811.00	$205
Premiums on Close	-$233.00	-$101.00	-$0.00
Fees Paid (total)	-$42.48	-$14.30	-$2.04
Ending Account Balance	$17,453.03	$17,453.03	$17,453.03
Total Gain/Loss	$1,453.03	$395.83	-$96.91
ROR		2.3%	-0.6%
ROC	9.1%

Progress Graph

(Note: the negative weekly results for weeks 4, 8, 12 and 17 are when I withdrew $300 from the Trading Account for my paycheck.)

My Performance vs. SPY

Hypothetically, instead of depositing $16,000 in my Options Trading Account, could I have done better if I bought $16,000 of the ETF/SPY instead?

	Options Trading	SPY (Fictional)
Initial Investment (As of Jan 4, 2021)	$16,000 (Cash)	$16,000 (43.39 shares @ $368.55)
Funds Added	$2,723.38 (Premiums)	0.31 shares (Dividends Reinvested)
Funds Removed	-$273.44 (Early Close & Fees)	$0 (Fractional Shares Sold)
Ending Balance	$18,449.94 (Cash)	$18,233.98 (43.70 shares * $417.30 CV)
ROI	+16.6%	+14.0%

Schedule for this Week

Goals for this week: (04/24/2021 – 04/30/2021) (Week #17)

• Document lessons learned or new thoughts
• Open one or two wide-strike spread
• Update Trading Log as trades occurs

Monday:

• Determine/update this week’s market sentiment section
• Calculate/record Put/Call Ratios for all stocks on the watch list
• Review/tweak Trend-Channels for all stocks in the watch list
• Set target expiration dates for all options as follows:
  • Bull Credit Spreads: Jun 18 (6-8 weeks)
    Note: If there are no Options Chains published for the 8-week expiration, then use the next Options Chain down from 8-weeks (7-weeks, 6-weeks). Beyond 4-week expirations, only the monthly chains are available to trade.
• Look up Ex-Dividend dates for positions in/approaching ITM (MarketWatch/Calendar)
• Stage possible trades for all watch list stocks by 10:00 AM
• NO TRADING BEFORE 10 AM. (Let the Market find its direction after the weekend.)
• Watch one Webcast or take one online mini-course to be completed by Friday.

Tuesday – Thursday:

• Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movements.
• Submit a couple of Spreads, but keep a close watch. If one is accepted, cancel the others (we want only one new active trade per day).
• Be mindful of Entry Rules.

Friday:

• Review the total technical dollars at risk for this week. If significantly below $500, then submit additional spreads if prudent.
• Update and post weekly journal (this blog) with any lessons learned or strategy changes.

This Week’s Trade Activity

(As of 04/30/2021)

Spread Count Summary:

	Year 2021	Month Apr	Week #17
Vertical Bull Put Credit Spread	28	8	2
Vertical Bear Call Credit Spread	0	0	0
Vertical Bull Put Debit Spread	0	0	0
Vertical Bull Call Debit Spread	0	0	0
Margin Interest	1	0	0
Total	29	8	2

Current Dollars at Risk:

	Year 2021	Month Apr	Week #17
Vertical Bull Put Credit Spread	$10,598.	$9,689.	$2,295.
Vertical Bear Call Credit Spread	$0.	$0.	$0.
Vertical Bull Put Debit Spread	$0.	$0.	$0.
Vertical Bull Call Debit Spread	$0.	$0.	$0.
Iron Condor	$0.	$0.	$0.
Total Dollar Risk	$10,598.	$9,689.	$2,295.
Max Risk Allowed	$16,000.00	$8,000	$2,500.

April was functionally a 5-week trading month. Because of the 5th week, I went over on my Monthly max risk.

New Trades Opened This Week

(04/24/2021 – 04/30/2021)

IWM: 205p/195p  – Open 04/29/21 – Expires 06/04/21 – Max Gain = $70.00- Open Price = $227.79
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=84.8%, Head Room=-9.9%, Max Loss=$930.00, ROC 7.4%, 36d Dev = $4.11

IWM: 205p/190p  – Open 04/28/21 – Expires 06/18/21 – Max Gain = $134.00- Open Price = $228.03
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.9%, Head Room=-10.2%, Max Loss=$1,366.00, ROC 9.7%, 51d Dev = $5.12

Entry Rules for Vertical Bull Put Credit Spreads:

• Current maximum dollars at risk < $16,000? Yes ($10,598)
• Max dollar at risk this week < $2,500? Yes ($2,295)
• Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (36 days)
• Long-term trend (four months) bullish? Yes (see chart)
• Short-term trajectory of the underlying bullish? Yes (see chart)
• Put/Call Ratio < 1, (or falling if it is > 1)? No (1.9 up from .9)
• Current price above 9-Day SMA?: Yes (see chart)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• Short-strike < 1 SD below the current price? Yes (1SD=210.10)
• Short-strikes Prob-OTM > 80%? Yes (84.8%)
• Short-Strike price below the trend channel at expiration?: Yes (see chart)
• Current price within the bottom 1/2 of Trend Channel?: Yes (see chart)
• Long-strike at maximum width (<= 15)? Yes (10 strike width)
• Set a GTC Conditional Trailing Stop Limit (CTSL): (Not Set)

With Option Chains for Jun 8 opening up, I picked on of these expiration dates for maintain some diversity.

Entry Rules for Vertical Bull Put Credit Spreads:

• Current maximum dollars at risk < $16,000? Yes ($9,669)
• Max dollar at risk this week < $2,500? Yes ($1,366)
• Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (51 days)
• Long-term trend (four months) bullish? Yes (see chart)
• Short-term trajectory of the underlying bullish? Yes (see chart)
• Put/Call Ratio < 1, (or falling if it is > 1)? No (2.3 up from 1.3)
• Current price above 9-Day SMA?: Yes (see chart)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• Short-strike < 1 SD below the current price? Yes (1SD=206.82)
• Short-strikes Prob-OTM > 80%? Yes (80.9%)
• Short-Strike price below the trend channel at expiration?: Yes (see chart)
• Current price within the bottom 1/2 of Trend Channel?: Yes (see chart)
• Long-strike at maximum width (<= 15)? Yes (15 strike width)
• Set a GTC Conditional Trailing Stop Limit (CTSL): (Not Set)

Trades Currently Cooking

(As of 04/30/2021)

DIA: 320p/310p  – Open 04/21/21 – Expires 05/28/21 – Max Gain = $75.00- Open Price = $340.69
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=84.1%, Head Room=-6.1%, Max Loss=$925.00, ROC 8.0%, 36d Dev = $5.40

SPY: 390p/375p  – Open 04/21/21 – Expires 05/28/21 – Max Gain = $107.00- Open Price = $415.85
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=82.3%, Head Room=-6.2%, Max Loss=$1,393.00, ROC 7.6%, 37d Dev = $9.65

IWM: 205p/195p  – Open 04/16/21 – Expires 05/28/21 – Max Gain = $100.00- Open Price = $244.17
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.3%, Head Room=-8.5%, Max Loss=$900.00, ROC 11.0%, 42d Dev = $5.42

QQQ: 310p/295p  – Open 04/14/21 – Expires 05/28/21 – Max Gain = $125.00- Open Price = $339.95
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=82.4%, Head Room=-8.8%, Max Loss=$1,374.00, ROC 9.0%, 44d Dev = $10.35

QQQ: 300p/280p  – Open 04/08/21 – Expires 05/21/21 – Max Gain = $119.00- Open Price = $333.83
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=85.4%, Head Room=-10.1%, Max Loss=$1,879.00, ROC 6.3%, 43d Dev = $7.80

IWM: 200p/190p  – Open 04/06/21 – Expires 05/21/21 – Max Gain = $80.00- Open Price = $225.02
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=83.8%, Head Room=-11.1%, Max Loss=$919.00, ROC 8.6%, 45d Dev = $5.80

DIA: 305p/390p  – Open 03/30/21 – Expires 05/21/21 – Max Gain = $131.00- Open Price = $318.83
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.0%, Head Room=-7.7%, Max Loss=$908.00, ROC 9.9%, 52d Dev = $6.9

Trades Closed This Week

(As of 04/30/2021)

No positions were closed this week.

IWM: 205p/195p  – Open 03/11/21 – Expires 04/23/21 – Max Gain = $103.00 – Open Price = $230.45
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.5%, Head Room=-11.4%, Max Loss=$896.00, ROC 11.4%, 43d Dev = 6.5
At Close: Prob. OTM=99.8%, Head Room=-8.7%, IV%=9.1%, ROR= 11.5%

Cost to open: $1.03 premium collected * 100 shares = $103.00
Cost to close: $0.0 premium paid * 100 shares = $0.00 (Expired worthless)
Net Profit= $103.00 to open – $0.00 to close = $103.00 – fees
Actual ROR = $103.00 / $896.00 = 11.5%

Conclusion

As the week comes to a close, I can see that I failed in achieving the goal of this Journal Entry. I neither explained what makes a good underlying nor where to find them. It could be said that this entry is necessary prerequisite information. So I am renaming the title “Picking the Right Stock for My Option Spreads – PT1.” I hope to return to this topic to learn how to broaden my inventory of possible underlyings.

Disclaimer

Even though I have tried to make it clear that this blog is my journal, documenting my trek into Options Trading, it has been suggested by others that I, nevertheless, include a general disclaimer. So here goes…

“This blog and the information contained herein is not intended to be a source of advice or analysis concerning the material presented. The information and/or documents contained in the blog do not constitute investment advice.”

Contact Me

To contact me or ask me a non-post related question, please use this form. If you want to comment on this post’s topic, please use the “Leave a Reply” box below so it can be attached to the post for future reference. – Thanks