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Conventional Investing vs. Investing the tastytrade Way

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Conventional Investing vs. Investing the tastytrade Way

  1. 1. Copyright© 2015 Craig E. Forman All Rights Reserved www.tastytrader.net A Real Financial Network for the Individual Investor How do the tastytrade® methods differ from conventional investment thinking?
  2. 2. Craig E. Forman www.tastytrader.net 2 Disclosure All investments involve risk and are not suitable for all investors. The past performance of a security, industry, sector, or market of a financial product does not guarantee future results or returns. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker or the Options Clearing Corporation at 1-888-OPTIONS or visit www.888options.com. Any strategies discussed here, including examples using actual securities and price data, are strictly for illustrative and education purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. The author of this presentation, and the content of the website www.tastytrader.net are in no way approved, endorsed, supported, or affiliated with tastytrade. We are a third party with interest in the tastytrade content, and the purpose of the information presented here is for education only. The ideas presented here are solely the views of the author, and are meant to enhance the ability of the individual investor in managing personal investments using the strategies and ideas set forth by tastytrade.
  3. 3. Craig E. Forman www.tastytrader.net Conventional tastytrade® way (1 of 2) 3 Trade Long Positions Only Trade both long and short positions as opportunities develop. Buy and Hold Trade often, taking profits when you have them, and extending duration when you are “on the dance floor”. Don’t put on too many positions Trade small with a high number of occurrences to create a high statistical chance of success. Take losses early, let winners run Manage your winners early, don’t manage losers if they are defined risk. Trade Directionally Strategy and duration trump direction. Derivatives (options and futures) are too risky Using derivatives gives you better leverage and allows better POP and ROC. Never sell naked options Use naked options with high IV rank when appropriate. Liquidity is not much of a concern Trade only underlyings with high liquidity. Focus is on P/L Focus is on POP, ROC, and cost basis reduction Trade with the market trend Look for opportunities to trade as a contrarian when at extremes. Avoid strategies like covered calls that limit your upside Methods of reducing cost basis increase the probability of profit, and should be utilized.
  4. 4. Craig E. Forman www.tastytrader.net Conventional tastytrade® way (2 of 2) 4 Use stops to protect against downside moves Don’t use stops, control risk by position size at entry, by using defined risk trades, and by using exit strategies for undefined risk trades at a loss. Minimize risk Be willing to take measured risk. You can take more risk on smaller trades since you are using a smaller percent of trading capital. Avoid margin –> account value can go negative Use margin responsibly to increase leverage and allow for more occurrences. Passive investing over a long period of time is preferable Being an active investor allows you to be more engaged, and will ultimately lead to a better understanding of investment options and better profitability. Stock prices will move up over the long term. While price is not mean reverting, we can take advantage of both low and high price extremes. Avoid trading when volatility is high Volatility is mean reverting. Use periods of high and low volatility extremes to guide your strategy. Individual investors are at a disadvantage when compared to institutional investors With today’s technology, individual investors have access to all the tools needed to invest strategically, and unlike institutional investors, they can get in and out of markets quickly. Avoid binary events such as earnings Use earnings and other binary events as an engagement tool, but stay small.
  5. 5. Craig E. Forman www.tastytrader.net tastytrade® way Explanation (1 of 2) 5 Trade both long and short positions as opportunities develop. An all long portfolio is not diversified – equities do not always go up. Trade often, taking profits when you have the opportunity, and extending duration when you are “on the dance floor”. A high number of occurrences is important to achieving overall positive returns. By extending duration, you give the trade more time to move into a profitable state. Trade small with a high number of occurrences to create a high statistical chance of success. Keeping trades small at entry will limit losses on losing positions and limit risk. With a high number of occurrences you have a better statistical chance at consistent results. Manage your winners early; don’t manage losers if they are defined risk. For undefined risk trades at a loss, use an exit strategy after adequate duration. Research shows that statistically, you will have a chance to close high probability trades at a profit at some point during the life of the trade, so managing winners early is critical to maintaining a high POP (probability of profit). Strategy and duration trump direction. By understanding probability and statistical chances of success, you can better develop profitable trading strategies. Using derivatives gives you better leverage and allows better POP and ROC. Using options, futures, index products, and volatility products allow you to trade strategically, allowing you to maximize probability of success. Use naked options with high IV rank when appropriate. Naked options have higher risk but can produce high POP when IV rank is high. Trade only underlyings with high liquidity. Wide bid-ask spreads make trading much more costly and reduces profitability. Focus is on POP, ROC, and Cost Basis Reduction. Understanding probabilities is key to putting on successful trades. Focusing on Cost basis reduction allows you to improve success rates and stay in trades longer. Look for opportunities to trade as a contrarian when at extremes. When markets are at extremes, there are often opportunities for some reversion to mean, so it is prudent to examine “fading the move”. Methods of reducing cost basis always increase the probability of profit, and should be utilized whenever possible. If given the option of increasing probability of profit at the expense of reducing upside, you should be willing to give up unlimited upside to achieve higher probability of success.
  6. 6. Craig E. Forman www.tastytrader.net tastytrade® way Explanation (2 of 2) 6 Don’t use stops, control risk by position size at entry, using defined risk trades and having an exit strategy for undefined risk trades. Stops can harm you in case of a flash crash or Black Swan event. Risk is high that you could be taken out at a very unfavorable price. Prices tend to normalize over time. Be willing to take measured risk. You can take more risk on smaller trades since you are using a smaller percent of trading capital. The amount of risk you take can be calculated when opening a new position, and the greater the risk, the greater the potential reward. One can enter a trade knowing the statistical chance of success, and the maximum possible profit. Use margin responsibly to increase leverage and allow for more occurrences. Trading within a Reg-T or Portfolio Margin account gives you far greater leverage than trading in a cash account. Note: IRA accounts have to be cash accounts (no margin). Being an active investor allows you to be more engaged, and will ultimately lead to a better understanding of investment options and better profitability. Once we understand how to use a variety of derivatives, we will be able to recognize strategic opportunity. Trading actively and taking advantage of strategic opportunity generates more predictability and less risk than passive investing. While prices are not mean reverting, we can take advantage of both low and high price extremes. When prices are at extreme highs, use short strategies, and when prices are at extreme lows, use long strategies. Volatility is mean reverting. Use periods of high and low volatility extremes to guide your strategy. High volatility provides the most opportunities for traders. When vol is at a low extreme, use strategies that benefit from increasing vol, and when vol is high, use strategies that benefit from decreasing vol. In high vol environments, the risk premium is often overstated, so selling premium gives you a statistical edge. With today’s technology, individual investors have access to the tools needed to invest strategically, and unlike institutional investors, they can get in and out of markets quickly. Trading platforms like TOS and Dough give the individual the ability to trade complex sets of financial instruments. The transaction costs have never been lower than they are today. Use earnings and other binary events as an engagement tool, but stay small. We trade binary events, but we keep our position size small, knowing that nobody can predict whether the underlying will react positively or negatively to the event. The only thing we can be sure of is that volatility will collapse as soon as the outcome is known.

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