It takes a lot of self-control not to develop a bunker mentality with the recent market gyrations. That's why I have been looking into pair trading. Pair trading is one of the more advanced trading techniques. You create offsetting positions in two different stocks, indices or futures, thereby capitalizing on the relative price changes between the two different positions. Sometimes, the difference between two stocks is more predictable than the direction of the individual stocks themselves. That is, no matter what the individual stocks are doing, a good pair might have the spread between them oscillate back and forth around a mean. When the spread gets too high, and you expect it to go back down, you can establish a short delta position in one index and a long delta position in the other index, and hopefully profit if the spread returns to its average off its high. For example, in TOS charts, type the symbol SPY-IWM in the symbol field. Then click on the "studies" button in the upper right hand corner; you can see I added a "spreads" study and a "correlations" study. We look for pairs that have an 80% correlation or higher. In this year-to-date (YTD) daily chart of SPY-IWM, the range is $70.53 - $36.05. The present price is around $42.00, and there is a nice correlation between the two ETFs of 83%.

A year to date (YTD) chart is good for a longer term approach, but I also look at shorter-term correlations. I want it to correspond to the approximate time of the trade. If I think that the spread will revert to its mean in one week, I might look at the five-day correlation. If I think the spread will revert in three months, I might look at the 90-day correlation. As you can see, the major difference between the two time frames is dramatic. You could make an argument that this pair trade is relatively low longer term on the YTD chart while you could also argue that it is approaching resistance on the short-term monthly chart if it hits its high of $45.97. Could it be long-term cheap and short-term expensive?

You can do pair trading with one click on the thinkorswim platform. Simply go to the "trade" tab and type in the two symbols with a minus sign in between. Click on the "ASK." In this example, you would be buying SPY and selling IWM with one click! SPY-IWM! Pair orders are much different from regular spread orders in the thinkorswim system, as both orders will be sent independently! If you choose to use limit orders, there is a chance you won't be filled on one or all of your order. This is one of the few times where you should consider using market orders to ensure that you get filled on both stocks and aren't legged out on one side! With tight penny-wide markets and huge volume in the ETFs, the slippage will be minimal and shouldn't be an issue.

Stocks have the most risk, but they respond most directly to the change. If the spread moves your way, the stock positions move point for point with the spread. But if you're wrong on the direction of the pair spread, there is no protection against the loss. Stocks are great for pairs trading if you are confident that the correlations will stay high and the spread will move in the direction you expect it to.

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.

Traders manage risk using a multitude of strategies, from order types and technical analysis, to stops, trail stops, OCO (one cancels other), bracket orders, triple tops, and double bottoms. However, with the VIX hovering north of 60% over the past two months, what has been effective risk management in this period of hyper-volatility?

First, it is imperative to understand that volatility (as measured via the VIX) is approximately three times its 20-year average. Yes, three times! The Vol is intimidating to even the most hardened traders, but more importantly, have you adjusted your risk management strategies to accommodate this unpredictability? What has been consistently overlooked by most traders is that with volatility three times the norm, you should have then cut capital allocations by 1/3. Furthermore, volatility has systematically ripped through stops, decimated technical levels, and gapped well and beyond any foreseeable trail stop or stop limit. In this period of intense volatility, risk management becomes more about strategies deployed and less about being right or wrong directionally.

I have always made the argument that at some point during the life of a trade it is both a winner and a loser. The key aspect is holding the position even throughout the most adverse market conditions in order to weather the volatility storm while remaining defined risk. Enter the defined risk vertical spread. The vertical spread allows the implementation of a defined-risk environment, and more importantly allows the position to mature without being stopped out. Here is a simple example of the benefits of a vertical spread in which we will risk $1.00 to make $1.00. Although this trade has no statistical advantage, it does provide a maximum sustainable risk of $1.00 and allows a directionally biased trader to hold even a losing position during extreme volatility. Any stock or single option trades in conjunction with variable order types would have been stopped out, yet the vertical spreads sustain the risk and keep the trader completely intact and in the position.

In future posts, we will dig deeply into the structure and deployment of defined-risk vertical spreads. In the meantime, keep your risk defined and your delta controlled!

thinkorswim, Inc. and its registered employee, Don Kaufman, 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.

Goodbye VIX 25, 35, and even 45. We might not see those levels for a long time. We could be looking at a VIX trading range bound from 53-80 for at least a couple of months, or until the economy starts to recover again. Take a look at the graph below to see how the recent range in the VIX has developed.

So how do you trade the market with the VIX as your guide? First, think about products to trade. What products have a correlation with the VIX? Any index ETF will suffice. I like to trade the DIA, but the SPY or IWM should follow a similar pattern. Second, use the VIX levels to determine whether to buy or sell premium. When the VIX gets back to the 80 levels, I add vertical spreads, not horizontal or time spreads. The premium is just too pricey to purchase. Take advantage of those juicy prices and sell verticals or iron condors that are in the 60%-75% probability of success range.

Once the VIX gets back down to the 53-55 range, as it did following its end-of-November rally, think about placing more horizontal spreads in your portfolio. I prefer to use diagonals in this environment, as they are relatively cheap right now compared to corresponding calendars. Diagonals can be used as directional plays as well. If you believe that the market is going to sell off, then buy a put diagonal. This strategy will create negative Delta and positive Theta while generating positive Vega. The positive Vega and negative Delta will perform well for your portfolio in a market downturn.

Use the VIX to determine whether or not to employ vertical or horizontal strategies. This type of trading involves constant adjustments to your option portfolio, but in this environment, it could mean the difference between profitability and loss. Happy trading.

thinkorswim, Inc. and its registered employee, Joe Kinahan, 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.

It just came to my attention that the National Bureau of Economic Research has declared that we are in fact in a recession. To top it off, they said it started in December 2007. My work is in the stock market, and my wife is a real estate agent, so this was obviously a major shock to us! She has been so busy doing open houses with zero people showing up and I've so busy consoling people who are losing chunks of their retirement accounts and comforting numerous friends who have lost their jobs that we did not notice that anything was any different with the economy.

Alright, maybe you noticed I am being a bit facetious and cynical here. Here is my point: we get it. We have been living it daily, so why do we need someone to tell us it is rough out there? Am I really going to trust these folks to tell me when it might end so I can comfortably dip my toes into the market consistently again? Let's see, they were about 9 months late (or about 40% in the broad based market) in pointing out what we already knew. So if I wait for the all clear sign from them I may be about 9 months too late if I am looking for a rebound.

I just want to implore folks to stay aware of all the information and news the economists and prognosticators are offering, but at the end of the day, use your own judgment in making trading decisions. Realize that the majority of the people advising folks did not see this coming and may be off on future predictions. Let's just process all the information we can get our hands on and make the best decisions we can.

This market is behaving in ways I have never seen in over 20 years in the business, so I am remaining very alert at all times in my trading. I am learning new ways to trade to be profitable. I realize this current trading environment is an anomaly, as you can see by the chart below. We probably will not see another year like this in our lifetime. I expect the market to return to a less volatile state within the next year, and I will reassess the strategies which may be beneficial in that environment. My point in taking us down this road is to encourage you to use this wildly volatile market to experiment with more trading strategies using options, stocks, currencies, futures or whatever products you like, and load your arsenal with more strategies. Of course, you should do it on a very small basis with tight stops and heavy monitoring to protect yourself. If you take this time to explore and learn, you can avoid being a one-trick pony in the market which is clearly tough these days. The strategies of yesterday are not producing today.

So what exactly am I talking about? I still sell option premium on a regular basis, but now I try to take advantage of elevated option premiums and sell spreads much wider than in the past. Additionally, I look for stocks that I think have nice rebound capabilities and I sell vertical put spreads or naked puts on them, depending on my risk tolerance. Finally, I look at some butterflies as they are so inexpensive due to the volatility and movement, which makes it nearly impossible to pick a landing price for a stock. Keep the helmet on and good luck!!

thinkorswim, Inc. and its registered employee, Steve Quirk, 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.

'Tis the season to increase the beltline with traditional holiday recipes! You all know what I'm talking about. This is the time of year that you pull yourself up to the table and eat that top-secret family recipe that you crave the other 11 months out of the year. So while you're whetting your appetite at the table, I've got another recipe that will whet your trading appetite. The recipe is called the Option Holiday Recipe. Here are the ingredients:

Price: When I say price, I'm referring to your directional bias. This could be up, down or sideways. If you are a Market Technician, you use trend, support and resistance. As the market trades sideways, you might want to look for market-neutral strategies. As the market is bullish or bearish you may skew your condors or butterflies, or sell your verticals in the appropriate direction.

Time: There are two things to consider with time: 1) Time decay. This is the one thing you can count on to make money day after day. It is the only constant in trading, for you know that an option will lose value each and every day; and 2) Time horizon. How long do you want to be in the trade? In this current volatile market, the most volatile market we have ever seen, a lot of trades have been shorter-term, and as such, one's ability to pick direction isn't as good. So make sure of two things: 1) you have positive time decay (theta); and 2) you trade based upon the time horizon or number of days you're comfortable with.

Volatility: To gauge volatility, use the VIX. When the VIX is high, you generally want to do those strategies that will benefit from a falling fix; these are negative vega. These strategies are verticals and anything that has to do with verticals- condors, butterflies, etc. When the VIX is low, consider those multi-month strategies that have a positive vega- calendars, diagonals, and double diagonals.

One question that I have been getting right now regarding the VIX is what is high and what is low? Look at the range that the VIX is trading in, otherwise known as support and resistance. Below you will see a chart of the VIX and its trading levels. Low would be in the range of 45-50 and high would be in the range of 75-80.

Putting it all Together:

Price: Pick a strategy based on directional bias.
Time: Make sure it's theta (time-decay) positive.
Volatility: Pick the strategy that allows you to profit from rising or falling volatility.

That, my friends, is the holiday recipe that keeps giving all year long!

Happy 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.

As congress deliberates over the auto industry bailout, investors are uncertain to lien into directional trading as evident in price action over the past month. If the bailout is passed and is successful in bolstering the economy, the sentiment would be bullish. If the measure doesn't pass or is not successful in bolstering the economy, bearish sentiment will be expected. This may seem an obvious statement but is that not what we want in choosing trades? Assuming it is a matter of when the bailout package is approved and not if, one might consider placing trades on the indices or even buying positions in GM and Ford. This may, in fact, be the reason the markets have maintained relative stability amidst the recent negative reports in the trade, manufacturing, housing, and labor data.

Are investors being too hopeful of the bailout working? What happened with the 700 billion dollar bailout? Did the market respond positively? Did the markets turn around and run positive from that point? Of course not; we had further sell-offs even when the bailout went through. What would make this bailout different?

I am not proposing being bearish or bullish. I am proposing preparing for significant moves in the days and weeks to come. In fact, the direction the market chooses for the next couple of months will likely not be decided in moments or even days after the bailout is approved and the details come to light. Instead, knee-jerk reactions, speculation and volatility will most assuredly appear in the aftermath of the approval. Over the past three years, higher volatility has strengthened the yen as larger investors covered short yen positions in the carry trade, while lower volatility has weakened it as investors sold yen during lower risk time periods. If volatility rises in response to the bailout, the yen likely will strengthen.

In addition to higher volatility, there is another factor that sets up the other half of the equation. Canada announced that it was willing to put in up to 20% of the bailout total value as the Canadian economy has a vested interest in the success of the U.S. auto industry. The U.S. auto industry receives many of its supplies from Canada. Without the auto industry, those suppliers will suffer greatly. Either through suffering auto industries or the fact Canada is going to dump potentially billions of Canadian dollars to support the auto industry, it might be expected that the Canadian dollar will weaken. Combining the potential of a weakening Canadian dollar and the potential of a strengthening yen would put pressure on the Canadian yen pair (CAD/JPY) to fall.

This is an intermediate time frame trade. It could take a week for the trade to confirm and multiple weeks for a price target to hit. From a chartist point of view, this could be seen as a descending triangle with some consolidation over the past two weeks (see figure 1). If the price pattern confirms and breaks below the support near 72.50, a potential move of 1,300 pips (85.50-72.50=13.00 or 1,300 pips) is possible for a price move to as low as 59.50. For all the non-spot forex traders, this is $1,430.00 per mini contract ($1.10 per pip) and $14,300.00 per full sized contract ($11.00 per pip). By waiting for a break out below support and putting a stop loss above recent resistance, a stop of 250-300 pips would be appropriate, providing between a 4:1 and 6:1 risk-reward.

Figure 1- Descending Triangle with Recent Consolidation and a 1,300 pips Potential.

If you wanted to set up the trade in the futures market, a synthetic position could be placed by buying yen futures (/6J) and selling Canadian dollar futures (/6C). If trading the futures this way but wanting to use the charting as described above, simply watch the CAD/JPY chart near your target (59.50) or stop (75.50) and consider exiting both the futures positions when the spot pair reaches one of the targets.

thinkorswim, Inc. does not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do be 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.