I get asked numerous questions when on the road about strike selection. For the most part, most swimmers understand the criteria of putting on a trade, but they don't understand which strikes to choose. Thus, I have come up with some of my own rules that I implement when I trade. You have to understand that we are premium sellers. That is the basis of how we make our money and how we put probability on our side. Once you understand that and truly believe it, the rest becomes easier.

First, I go to the Trade Tab on the TOS platform to set my information layouts to Probability of Expiring and Delta to determine which strike I want to sell. Personally, I look to sell the 35 delta, or namely 35% Probability of Expiring, and I buy the 25% Probability of Expiring, or 25 delta options against them for protection. In this instance, I have chosen the XLE 92/94 call vertical to sell. This usually involves me selling a two-strike wide call or put vertical, depending upon my directional bias. Yes, even though I am an anti-chartite, I do have directional biases. Why do I choose two-strike wide intervals as opposed to one-strike wide? For me, it comes down to the amount of credit, or premium, that I am selling. Usually, if I am comfortable selling 10 one-strike wide verticals, then I will sell 5 two-strike wide verticals to collect approximately the same premium while saving on commissions. Don't tell anybody I told you that.

I must, however, be aware that I will feel some "heat" on this position before it expires. This is known as Probability of Touching, and is usually twice the value of the Probability of Expiring. In my example up above, if my short strike has a Probability of Expiring of 35%, then the stock has approximately a 70% chance of touching my short strike before expiration. But remember, stocks move throughout the life of your positions. The only guarantee I will make you is this: If you always have a stop price set at your short strike, you will lose money! If this isn't clear, then go back to the Probability of Touching to see that 70% of the time your stop will be activated.

With that in mind, we have eliminated an adjustment many people make, Stop Orders. I don't like them, and I don't use them. Remember, your vertical acts as a defined risk order with a natural stop in it, your long strike. So, why add another stop on top of that especially when you now know how to read the Probability of Touching number.

Best of luck trading Swimmers. Next week I will return to my Alcoa example to show you a trade I like to make going into earnings season.

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Option traders rely on the VIX for a number of reasons. One of those reasons is to help them spot tops and bottoms in the market. When the market hits a bottom, the VIX is usually trading at an extreme. For example, on March 17th the VIX blew through 33 while the SPX found a bottom at 1275. On January 22nd the VIX blew through 33 again while the SPX again found a bottom at 1275. In both examples the market began to rally afterward.

So what is missing now? The market continues to head downward while the VIX trades around 23. Don't get me wrong, a 23 VIX does allow you to sell some pretty good premium which is what we like to do, but if you're trying to time the bottom, a blow off in the VIX sure would help in doing just that.
Successful Trading!
thinkorswim, Inc. does not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Neither Investools nor its educational subsidiaries nor any of their respective officers, personnel, representatives, agents or independent contractors are, in such capacities, licensed financial advisers, registered investment advisers or registered broker-dealers. Neither Investools nor such educational subsidiaries provide investment or financial advice or make investment recommendations, nor are they in the business of transacting trades, nor do they direct client commodity accounts or give commodity trading advice tailored to any particular client's situation. Nothing contained in this communication constitutes a solicitation, recommendation, promotion, endorsement or offer by Investools, or others described above, of any particular security, transaction or investment.

Writing on July 3rd. Happy Independence Day and welcome back to the Daily Swim. As I wrote about before, earnings season will soon be upon us with July 8th marking the beginning of the season and the announcement of Alcoa (AA) earnings. Hopefully, you have been tracking the front month implied volatility since my last post when July volatility was trading 52%. As I noted before, implied volatility tends to increase as the earnings date approaches. If we look at the July volatility as of July 3rd, AA front month volatility is now trading 64% with five days to go until earnings. So, what does this mean to you as traders and how can you make money off of the move in volatility?

One strategy that I like to implement when trading single stock volatility in products such as Alcoa (AA) is to buy the nearest back month options, in this case August, about one week before the earnings announcement. Even though this strategy will result in paying decay and add some delta risk, for that one week, the amount of decay is usually minimal as the implied volatility increases. Remember, volatility is uncertainty. Uncertainty about Alcoa's earnings will keep the implied volatility inflated, as we can see from the 12% increase over the past month. Once I now own the August options, I wait until the day before earnings to sell the corresponding strike in the front month, July, to take advantage of the difference in implied volatilities between the two months. In essence, I have legged myself into a calendar spread while working for better execution by waiting until the July premium is fully inflated. This usually occurs the day before or the day of earnings. You can make this a directional play by choosing the call or put calendar. For instance, if you believe Alcoa stock will sell off after the earnings announcement, then the put calendar would be a better play. In our case, for Alcoa, the July/August 30 put calendar would represent a bearish bias. I prefer to place my earnings calendars at the at-the-money strike if I do not have a bearish or bullish bias. Just remember that calendars are short gamma positions, so large moves in the underlying are detrimental to the value of the calendar.

In order to see how far Alcoa can move in our at-the-money calendar example to capture a profit, I have created a simulated trade using the thinkorswim Analyze Tab. As you can see, the calendar, as of July 3rd, would cost about $88 per one lot. In my example, I have chosen to buy five calendars for a total debit of $440. Now as we move closer to the earnings date, we could leg into the calendar to reduce that cost. Our maximum profit occurs if the stock settles at $32.50, however, we continue to make money as long as Alcoa stays between our Break Even points of $30.20 and $35.22. If you believe that this will be the case, then this might be a strategy to consider.

Let's keep an eye on Alcoa to see how it performs over the next week. Until then, best of luck trading.

Joe Mazzola

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Welcome back Swimmers.

Let's take a look at the Alcoa calendar trade we were following going into the company's earnings announcement on July 8th. I will be using thinkBack to look at a couple of key points we talked about before. Let's refresh our memories. First, we said we can expect implied volatility to rise going into the earnings date on both the front-month July and the back-month August. Second, we said that we could buy the calendar for .89 a couple of days in advance of the earnings date and looked at the Analyze tab to see how far the stock could move in either direction in order for us to keep our money on the trade. So, using the thinkBack tab, let's take a look at the implied volatilities at the close on July 8th prior to the earnings announcement.

As we can see the implied volatilities of both months are decidedly higher than where they were from the first post. In all fairness, the market has sold off pushing implied volatility levels higher in most stocks, but Alcoa is around the same level price-wise that it was from my first post. The rise in implied volatility is due to the uncertainty of the earnings and future revenue announcements. As we stated above, the calendar value prior to the earnings date was .89, meaning that for $89 you could buy the July/August 32.50 calendar. Also remember that a long calendar position is a short gamma, long vega position that maximizes in value if the stock is resting at your short July strike at expiration. However, you didn't need to hold the position till expiration to make money on this trade. Let's take a look at the value of that calendar on Friday July 11th. The value of that same calendar is now 1.15, with the stock trading $34, so we made about a 28% return in a matter of a week. That is not bad, and given the market sell-off recently, any gain is a good gain. Happy trading everyone!

Joe Mazzola

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

I travel around the country and often meet many of our TOS customers along the way- and it seems like everyone is trading the RUT! Sure, I see the advantages to this broad-based ETF that tracks the Russell 2000. It has good open interest, is fairly liquid and has deep markets. It is $0.20-$0.50-wide with $10.00-wide strikes, has volatility, and it is supported by multiple exchanges. And the RUT's high premiums in options make it a premium seller's dream! But wait. I think that for most customers there is a better product to trade: IWM. Let me explain. What most people don't realize is that the RUT is the big brother to the IWM, as the IWM is one-tenth the size of the RUT. The IWM is also an ETF on the Russell 2000, but has better open interest. It is very liquid and has deep markets, and is $0.01-$0.05-wide with $1.00-wide strikes. It has the same volatility and is also supported by multiple exchanges. All this, combined with its high premiums in options, makes the IWM a smart premium seller's dream!

As you can see, there are some similarities between each product, but their differences are convincing enough to show you why you should take another look at IWM when considering a Russell IWM trade.

1. Trading on Expiration Friday: This is the most surprising difference- you can't trade RUT on expiration Friday! It's not open for front-month trading. All trading in the front month is closed on Thursday, but RUT settlement prices come out after all 2000 stocks are eventually opened on Friday's prices! Usually you'll find out the settlement prices at around 1pm CST, but often you can't even find out what the price is until after Friday's close. That leaves way too much market manipulation for my high-probably personality- you have no control over your positions! Hoping and praying is NOT an options strategy. What are you supposed to do? IWM's front-month strikes trade like most ETFs and expire at the close of trading on FRIDAY. Ahh...full control of my positions!

2. Tighter Markets: There are tighter markets in IWM. Individual strikes in the RUT are usually $0.20-$0.50 wide; the equivalent of a $0.02-$0.05 market in the IWM. Yet the IWM markets are mostly just $0.01-$0.03 wide. Recent $10.00-wide-strike Iron Condor markets in the RUT are $0.60 wide and often won't be filled nt the mid price, meaning you have to lower your price to execute the order. Conversely, recent $1.00-wide-strike Iron Condor markets in the IWM are $0.04 wide (the equivalent of a $0.40-wide market in RUT), and often WILL be filled at the mid price. Better fill prices means more cash in your pockets- not some money-maker's!

3. Distribution: Flexibility among strikes and price discoveries means a higher probability of success. With IWM you can trade 1-10 Iron Condors before you have the same "buying power effect" of just one RUT Iron Condor, allowing you to work orders over multiple strikes and take better advantage of market movement. The only disadvantage to trading IWM versus the RUT is higher commissions. But remember, if you do what I outlined above, you will be receiving a better price for your spread, more than making up for the higher commissions. And eventually, you'll be making 40 trades in one month and you can start receiving a $39.95 rebate check from TOS. Sweet Suite!

thinkorswim, Inc. and its employee, Tony Battista, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.