By Josip Causic, Online Trading Academy Options Instructor
Many times I receive interesting questions from our graduates in my email box, and occasionally, I like to share them with our general reading audience. Here are some of the questions that I was asked recently. Some questions are related to the topics of options, others to stop losses, while others are on the topic of ETFs. Hence, in this newsletter there is a bit for everyone.
"I am a graduate from Singapore and I just attended your recorded version on Inverse ETFs. I have a question with regards to options. Since we are able to buy and write options and even do verticals, condors and butterflies, why would we ever need to use inverse ETFs?"
Inverse ETFs were initially invented as a way to bypass the restriction of not being able to be short in retirement accounts. Now many other traders and institutions are using them as a way of hedging their portfolios.
"We can simply use a normal ETF like QQQQ or SPY and construct our strategies normally in either bear or even a bull market. Does this understanding make sense to you?"
Yes, it does and you are spot on when stating that as option traders, we might not need those products such as inverse and leveraged ETFs.
"My question again, for options, since we have verticals and such, how probable is it that we need to use stop losses? The only circumstance that I could think of when stop losses make sense in options is when we are long options. Is this understanding correct?"
There are two types of options traders: Spread traders and directional traders who simply just buy calls and puts. It is true that for directional option trading, you must use stop losses. Yet, make no mistake about verticals and other spread trades. You do need to have an exact plan at which level your trade has gone against you and you need to either exit it for a loss or buy back your obligations. A word of advice: Have an exit strategy pre-calculated on every single trade and make sure to do exactly what Online Trading Academy teaches. Plan the Trade, Trade the Plan.
There are some students who have a problem with the platform and here is a typical question that I get: "I had TradeStation up and running during your charting session regarding stops, and I could not get my DIA daily, monthly, 15-min, etc, charts to look anything like yours. I got my background changed from black to white and have candlesticks in green and red, but other than that, my chart never seems to look like the ones I see in 'Lessons from the Pros' and the 'Hour with the Pros.' Can you help me?"
The easiest way to help you is to suggest that you take our Platform Immersion class. During our Professional Trader classes, the aim is to teach how to trade and not necessarily how to use TradeStation. Another way that will help you out with utilizing the TradeStation Platform effectively is to watch the TradeStation tutorials on the link below.
https://www.tradestation.com/support/tutorials/default.aspx
Another student has asked me this: "What do you think about using price channels that have worked in the past for a given stock (plus a little buffer) to set stops?"
I love to spread trade an underlying that is in a channel. I tend to trade this with Iron Condors and there are many articles that I have written on that topic, such as Unwinding an Iron Condor.
Your question about the "buffer" stops sounds reasonable, but be aware of the fact that you should never be too generous with stops and placing the correct stops is more an art than an exact science. It depends on your personal level of tolerance and your risk management rules. At any given time when placing stop losses, be aware of what type of trade you are in. Are you an Intraday Trader? If yes, then place very tight stops. If you are a Swing Trader, then your stop losses must be looser than the ones for an intraday trade. Start by asking yourself, "What type of trader am I?" Then, when you answer that question, proceed with placing the stops.
Another graduate had two more questions
"I have two questions:
- You have indicated that the ultra ETFs do not perform as they're supposed to. When I calculated the return of SSO since the March 9th, 2009 low, I found that it performed 2.66 times the S&P 500. It's more than twice.
- How do you use ATR in setting stop losses for a swing or position trader? Have you heard of calculating the stop loss by subtracting 2xATR from the days' high price? If you have, what do you think of this method? Thanks."
In the case of the SSO you are correct that during the time that you researched, the SSO moved more than twice the S&P. The bottom line is that many of the leveraged ETFs move correctly within their daily performance, yet on the bigger time frame, they move at different rates. This is because leveraged ETFs attempt to achieve the extra returns using financial engineering, which is not always precise. It is good to know, prior to trading them, that there is often a discrepancy between what they are supposed to do versus what they, in fact, do.
The second question on the ATR (Average True Range) requires so much more space than what I am given in this article, so anticipate a future newsletter on that topic. The point of using the ATR is simple. If the stock trades at or around $45 and has a daily ATR of 0.66, having an intraday stop loss on 0.30 cents is inside the natural vibration of the stock. For a swing trade, it is wise to place the stop loss greater than its ATR. The moment you get into twice the ATR, the time frame of the trade expands. Be aware of that and have good trading.
In this newsletter, I have answered some student questions on various topics. In the next one, I will be back on the topic of Butterflies. Until then, watch your position sizing and keep everything in moderation including the share size.
- Josip Causic
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