Thursday, February 23, 2012

join tastytrade and get my thinkScripts

if you join tastytrade by following this link, thereby generating a referal bonus to me, then i will reward you back by sending you the import files for my portfolio of thinkScript studies (see chewToys.)

costs you nothing, gets you everything!


note: if you do this please email me at so i can reply back with the import files - tastytrade does not share your information.

Tuesday, February 14, 2012

Edge Think

The other day I was listening to a trader, who runs a paid subscription blog, talk about his trading strategy on an internet show and my recent posts about edge guided me away from this particular person's strategy. So I thought I'd brain-dump on this a bit.

The strategy in question is highly acclaimed, by some, because it stays in-trade longer. Thus a winning trade is a big winner. The entry/exit strategy is indicator driven so there is not a pre-defined risk/reward. Well, that sounds great, sign me up. However, later on in the show, during a call-in period, a caller asked about his win/loss ratio. The reply given was that win/loss was not important but the average gain was 5 times the average loss.

Hmmm... He ducked the win/loss question and volunteered reward/risk instead. This excited my think-for-yourself circuitry. A reward/risk of 5 is really a risk/reward of 1/5 but he chose to present this information in its most favorable inversion. That in of itself is not indictable but he also declined to tell us an important piece of information that would enable a consumer to evaluate what sort of trading advantage he has achieved with the strategy, the win/loss ratio.

Rather than calling BS outright let's take a more generous interpretation of this behavior. Perhaps this trader is just not overly proud of the win/loss ratio because it is, maybe, a little too close to the break-even value of 1/5. His win/loss ratio has to be worse than flipping a coin, otherwise there would be such a huge edge to this strategy that he would already own his own island. So let's split the difference and guess that win/loss is perhaps, 3/5. Thus, his trading advantage is something like .15 (=3/8 * (3/5 - 1/5)), or an expected 15 cents return per dollar of risk. Which is actually pretty decent, if true.

However, I have trouble with any win/loss ratio that is less than one. This is because runs of luck in coin-flipping are well known and are expected to produce several runs of 6 or 7 in 100 tosses.  Now suppose you are tossing a rigged coin that favors heads, 5/3, and you are a tails caller. You should expect longer and more runs of heads than a fair coin.  I would quickly abandon a strategy if I were to get many losing trades and the strategy only has a statistical edge that is not well documented. Better yet, don't even adopt such a strategy. Then again, maybe that is just me and I have learned something about myself: I need to see many small wins to keep my confidence level high.

Tuesday, February 7, 2012

ThinkScript Included: MarketForecast With Overbought/Sold Lines

The MarketForecast is a proprietary indicator that many of us Investools and Prophet Chart students/users were eagerly awaiting to arrive in TOS Charts. Well, they are here, in the new MarketForecast study but if you are used to seeing the MFC on prophet charts or on the Investools website there is a glaring omission: no overbought/sold lines. If you want those lines you might attempt to use the price-level drawing tool to add them but you will have to draw them for every equity you chart. The lines need to be part of the study. I could send ThinkOrSwim a feature request email but it is easy enough for me to get the ob, os lines by writing my own study. So here's the image of the study:

SPY, 1 month daily chart with sdi_mfc study.
Here's the code:

Sunday, February 5, 2012

Rolling-Up A Covered Call

A point of resistance to participating in covered-calls for many traders is the perception that once the price rises above the strike price you forego all further opportunity for profit. In my experience, for most equities, this is not true. First of all, one can always roll the call. Rolling is an operation whereby a trader buys back a soon-to-be-expiring call and sells an option at the same strike with more time-to-expiration. This is a standard operation and many brokerages, including ThinkOrSwim, can execute rolls in a single trade and usually for a credit on short-option rolls.

Where does that leave you? After rolling a covered-call, one is left with an in-the-money, short-option. This doesn't look good the first time you see it because it may have a small extrinsic value but here's a few points to be mindful of:
  1. Higher potential gain. If you rolled for a credit then the new short-option will have its entry-price set up higher than the first initiating call you sold and this represents higher potential profit. Buy-back that rolled option for cents on the dollar and you definitely win.
  2. Higher delta. Presumably one initiated the covered call out-of-the money which is always less than 50 delta. If you rolled an in-the-money call then the delta of the new short-option will be somewhere north of 50. Now, if the equity starts to slide then the gain in the new covered-call accumulates more rapidly than it would have in the originating call.
  3. Direction rarely holds for very long. Most stocks zig-zag their way up due to profit taking.
  4. You have all the time in the world. The shares you purchased don't expire so you can keep rolling the calls almost indefinitely.
These circumstances lead to opportunities to advance the strike price of a covered-call for little cost or even a credit. What one is looking for is a pullback after rolling the ITM call and preferably near the expiration of the new call. This pullback will produce a fat gain in the ITM call but your budget for rolling-up is the total of the accumulated roll-credits.

What we are looking to do is what is called a diagonal roll. We are seeking to roll our ITM call up in strike price and out in time. We are seeking to roll the call diagonally up for something like the accumulated roll-credits. If this up-diagonal prices, net of accumulated roll credits, for a credit or even a small debit (like a typical roll-value if you want to forward-invest the next roll credit, say) then it is worth the doing, because you lock-in the price differential of the strike prices in the underlying equity. Keep in mind that rolling diagonally down is almost always a steep credit and thus, easy. In this manner, given sufficient patience, it is almost always possible to advance the strike price of a covered call. Thus, there is a pathway to make money with covered-calls on the way up as well as down ... provided, of course, that the options of the underlying equity are relatively liquid.

Illiquidity is the gotcha to any option strategy. So be sure to choose an equity with liquid options - look at the front-month at-the-money options. The bid-ask spread should be no more than 10-20 cents. In the front-month there should be thousands of contracts of open-interest and triple digit open-interest in the ATM strikes. If not, then maybe don't trade the options. It hasn't always stopped me from selling covered-calls but I'm more willing to let the shares go if they go in-the-money.