Not sure if you’ve heard, but I’ve been asking members of the OptionSIZZLE community to send me their hard-hitting questions pertaining to options. Let’s face it, many of us our going through some of the same issues when it comes to options investing. With that said, I thought by sharing these responses with you here, we all could get something out of it. Let’s get started with the first question.

1. SIZZLE Mailbag No.1
Unusual Options
Activity Part I

2. Not sure if you’ve heard, but I’ve been
asking members of the OptionSIZZLE
community to send me their hard-hitting
questions pertaining to options.
Let’s face it, many of us our going through
some of the same issues when it comes to
options investing.

3. With that said, I thought by sharing these
responses with you here, we all could get
something out of it.
Let’s get started with the first question.

4. Hi Joshua,
I found your report on unusual options to be very helpful,
especially the part about following a successful roll.
I have some questions for you, hopefully you can provide
answers. I am a novice trader and don’t plan on
becoming a professional. So I don’t have access to the
same tools as you.
However, I usually follow the options flow posted on
Twitter or Stocktwits. Now, when I followed some of
these trades, they ended up moving in the wrong
direction and I took a big loss.

5. Question 1: How do I decide when it’s time to stop out
of a trade and take a loss?
In the past two months, I won some, but lost more.
The most painful part, is taking a loss and then seeing
the trade becoming profitable without me.
For example, I followed FSLR April 70 Calls, it dropped
sharply, I got out. A few weeks later, news was
released and it rose sharply and traded above 75!

6. Response:
First, let me say that I’ve experienced what you’re
going through. And to be honest, there’s nothing
more frustrating than getting out of a position for a
loss…only to see it rebound and come back. Of
course, not every trade is going be a winner and
there is nothing wrong with getting out once your
pain threshold is met.
However, it makes a lot of sense to evaluate your
losing trades and ask yourself if there was anything
you could have done differently.

7. Here are my thoughts:
We never know if an unusual options trade is
done for speculative or hedging purposes.
However, that shouldn’t stop us from trying to
be inner detectives.
That’s why I constantly ask myself:
Is this order done for technical reasons (bullish
or bearish chart patterns, breakout or
breakdown etc.)?

8. Is there an event coming up (analyst day,
earnings, conferences, pending legal
announcement, FDA release etc.)?
Is this company a potential acquisition or
involved in one (M&A rumors)?
Is there an activist hedge fund manager
involved with the stock (Carl Icahn. Daniel
Loeb etc.)?

9. Is this sector getting bought? For example,
are we seeing strength in all solar names or
is this isolated.
Is this stock vulnerable to economic news or
highly correlated to the broad market?

10. If you go through the report again, you’ll
notice there are even more questions for you
to consider.
But I think you get the picture. The goal is
really to try to figure out what the potential
catalyst might be.
Of course, sometimes we can be completely
blind-sided, only finding out what the catalyst
was after the fact.

11. In this case, First Solar, Inc. (FSLR) had an
analyst day on 3/19/14. Typically, analyst
notes are followed after an event like this.
An analyst note is simply a report on the
company along with a price target and their
justification for that price target.

12. Now, it turned out that almost every analyst
on the street upgraded their price target on
FSLR after the analyst day.
UBS $55 to $72
Deutsche Bank $50 to $70
JP Morgan $31 to $51
RBC $67 to $87
So on and so forth…

13. If I were to guess, the order flow you saw was
a speculative bet that FSLR would have a
positive analyst day. In fact, that week, the
stock price jumped 32.91% to $73.37.
OK, so we just identified the potential catalyst.
And you didn’t need any fancy software or
analytics to figure out. In fact, YAHOO! Finance
has a pretty good news service (that’s
free). You can check it out here:

14. Moving on.
You mentioned that the position moved
against you so much that you had to bail out.
Here are two things to consider:
It boils down to position sizing. If this is a bet
on an event, we have to treat it like a binary
trade. This simply means that it’s going to be a
winner or a loser.

15. For example, if I decide to trade binary
events, I size accordingly. If my max loss on
a trade is $1000 and the contracts are
priced at $0.50.
I will only buy 20 contracts, with the idea
that there is a good chance of losing it all. If
I’m wrong and the event passes, I’ll try to
salvage any premium that’s left.

16. To put it into context, if I normally risk 3% of
my account size on any given trade. On
binary trades, I’ll risk 1 to 1.5%.
Why?
Because they’re super risky and if I’m right
the stock should really pop…so there is no
reason to have a lot on.

17. Also, these are near term contracts, the
premiums have the potential to move very
quickly.
I don’t want to be in a position, where I
have too many contracts on and I am forced
to get out before the event occurs (because
the losses are too big).

18. By keeping your position size small, you
have the ability to see the trade play out. It
seems like you had too many positions on.
Now, let’s assume we don’t know what the
potential catalyst is. I’ll then look at the
option volatility. What does this mean?
Well, I will look at the implied volatility of
the options.

19. Let’s say the at-the-money options have an
implied volatility of 60%. Implied volatility is
expressed in annualized terms.
However, most investors have a greater feel
for volatility in daily terms. With that said, I
would take that .60 and divide it by 16
(rounded off, it’s the square root of the
number of trading days in a year).

20. You don’t have to get caught up in the
jargon…just know that if you take the implied
volatility and divide it by 16, you’ll convert
annualized volatility to daily volatility.
.60/16 = .0375 or 3.75%
This means that the option market is implying
that the stock could move +/- 3.75%.

21. For example, if the stock price moved 3%
today that would be considered a normal
move. In other words, that 3.75% is a one
standard deviation move.
Bottom line, if the stock experiences a lot of
price volatility and it’s a near term option…I
want to trade small because I don’t want to
get stopped out.

22. As you can see, the way you size your
position should vary based on the time
frame of the options, the potential catalyst
and structure of the trade.
If you read, “The Ugly Truth About Buying
Options” you’ll recall how quickly extrinsic
value gets sucked out of options as they
near expiration.

23. Bottom line, this was a trade that was
based on upcoming event and you were not
sized correctly.
It’s also worth considering other trade
structures in the future. For example, if
you’ve read, “How to Underperform the
Market and Get Paid Like a Rock Star” you’ll
know that I’m a huge fan of structured
option positions.

24. In addition, if you read, “Why You Should
Avoid Trading Options All Together” you’ll
know that I like to sell puts vs. buying stock
or calls if I have a bullish bias on a stock.
In Part II I’ll be going over a position
management question. If you’d like to get
involved with the action, just send me an
email, message on Twitter orFacebook.

25. Of course, you could always share your
thoughts in the comments section below.
I’d love to hear from you.