July 2008 Letters To The Editor
or return to July 2008 Contents
The editors of S&C invite readers to submit their opinions and
information on subjects relating to technical analysis and this magazine.
This column is our means of communication with our readers. Is there something
you would like to know more (or less) about? Tell us about it. Without
a source of new ideas and subjects coming from our readers, this magazine
would not exist.
Address your correspondence to: Editor, STOCKS & COMMODITIES,
4757 California Ave. SW, Seattle, WA 98116-4499, or E-mail to editor@traders.com.
All letters become the property of Technical Analysis, Inc. Letter-writers
must include their full name and address for verification. Letters may
be edited for length or clarity. The opinions expressed in this column
do not necessarily represent those of the magazine. -Editor
OPTIONS: THE MISSING LINK
Editor,
In the May 2008 STOCKS & COMMODITIES article "Options: The
Missing Link," author Martha Stokes makes some good points about the dangers
of option trading and the necessity of understanding the basics of stock
trading. But the article also contains some statements that are likely
to confuse people who are not well-versed in option strategies.
For example, in the last paragraph of the section "Smaller capital
base = more risks," Stokes states, "If the stock moves up then the sell
option expires worthless, but the buy option makes money and vice versa."
However, in a straddle, the trader is either a) buying a call and buying
a put, or b) selling a call and selling a put. There is no such thing as
a "buy option" and "sell option" within the same straddle. You're either
buying both options or selling both options.
If what the author really means is that a long call is the equivalent
of buying stock and a long put is the equivalent of selling stock (this
is apparently what she's getting at), she needs to state the issue differently,
so as not to confuse people who may not have a firm foundation in options.
Another example is at the bottom of page 18 in the last paragraph
before the "Implied volatility" section. The author states: "...they would
only use straddles in the impending direction with which the stock agrees...."
Straddles, by their nature, are nondirectional strategies, so it is impossible
to use a straddle in an "impending direction." If you're buying a straddle
(buy call and buy put), you're betting that the underlying stock is going
to make a big move within a certain amount of time, but you have no opinion
on the direction of that move. If you're selling a straddle (sell call
and sell put) you're betting that the underlying will continue to move
sideways within a range over a certain period.
Again, the way this is stated in the article is only going to
confuse people who are trying to come to grips with a more secure understanding
of options.
David H. James, CFA
Martha Stokes replies:
I agree with you that the passages you mention from my May 2008 article
were confusing and need clarification. I attempted to keep this article
within a limited number of words and tried to avoid a lengthy discussion
of option strategies detail, since the subject matter was about technical
analysis for options. I apologize if this caused a lack of explanation.
Let me clarify.
Since options can be confusing for novices (that is, those with less
than three years of experience), I teach my students to use the following
terms:
Long a call or long a put: You open a position by either buying a call
or buying a put. By using a call, you are intending to go long in the stock,
since your analysis of the stock chart indicates that the stock is going
to move up in price. By using a put, you are intending to go short in a
stock, since your analysis of the stock chart indicates the stock is going
to move down. You should always think in terms of what the ultimate outcome
could be, which is that the option could be exercised and you would take
a long or short position in the stock, depending on which option you held.
Option writer (selling a call or put): You open a position by
either selling a call or selling a put. Another way to look at option writing
is that you are acting as a broker for the stock. Sometimes thinking about
it in this way makes it easier for novices. So you are obligated to either
sell stock if the short call option is exercised or buy stock if the short
put option is exercised. Always think of the ultimate outcome that could
occur if you are assigned. That way, you are aware of what position you
are trading the underlying stock.
Spreads: You are either long, or a writer, or doing both at the
same time for some option strategies, such as spreads. There are numerous
variations on spreads, so I will name a few:
Bull/bear call spread: You are both a buyer and a writer. You
are buying a call and you are writing a call.
Bull/bear put spread: You buy a put and write a put. So you
are both a buyer and a writer.
Collar: You buy a protective put and you write a covered call.
Strangle: Buying a call and a put or writing a call and a put
with an out-of-the-money strike price.
Straddle: Buying a call and buying a put or writing a call and
writing a put for the same strike price.
Calendar: Buying an option and then writing an option in a different
expiration month.
There are numerous other option strategies that also involve both holding
and writing at the same time in three to four different open positions.
It was my intention in the article to explain that when a stock is moving
sideways, which occurs 40-50% of the time in the markets these days,
using a straddle in which you are buying a call and buying a put is not
an ideal strategy to use. This is because it places you in both a long
and a short at the same time. (In the article, I was referring only to
being long a straddle, not writing one.)
This strategy appeals to novices because they believe they can't lose.
They are hoping that the stock will either move up significantly or move
down significantly (meaning many points), and the gain from whichever premium
increases in relation to the stock price action will be sufficient to make
a good profit. The theory behind this option strategy is that the trader
"has no opinion" about the direction the stock will take, but believes
it will move many points up or down.
First, not having an opinion when you are trading is not a good idea.
One should always know the market condition and have sufficiently analyzed
the stock or other trading instrument to be able to make a decisive, confident
decision. Second, from where does an option trader derive the opinion that
the stock will move many points when it breaks out of the sideways pattern?
How does the trader determine how many points it will move if he or she
has no opinion about the direction it will take? What levels of resistance
or support is the trader using to calculate the impending moves both up
and down? The truth is that most novices don't even think about any of
these aspects of technical analysis before entering a straddle.
I have taught thousands of students for over a decade and I know that
a lack of opinion is not really what occurs with novices. What actually
causes novices to use a buy call/buy put straddle is that they don't know
what the stock is going to do and they are hoping it will do something.
This ultimately leads to losses.
My point in writing the article was the following: If you are able to
read stock charts with skill, you would seldom, if ever, use a straddle.
This is because you would not be "without an opinion" of what the stock
would do. You would know the point potential, the potential for velocity
behind the move, the duration of the move, and so on. Most novice traders
who use long call/put straddles simply lack the education and the confidence
that comes from being properly trained.
A well-trained technical analyst will have a good idea which way the
stock will go as it breaks out of a sideways or consolidation price pattern.
Studying such things as the angle of ascent; price compression patterns;
volume surge and spike patterns; and accumulation or distribution patterns
that occur during sideways and consolidation patterns all assist in this
analysis and provide reliable information about the direction the stock
will likely take. With that information, using a straddle is no longer
the best choice for an option trade. Here's why: When you use a straddle,
you will always have one position that ends up being worthless. But you
can also end up with both contracts being worthless.
In theory, straddles sound wonderful. There is the appeal of the lower
risk, since at least one side will make you money. But the statistics for
option traders show otherwise: 90% of all option traders lose money on
a regular basis.
That's not a good statistic to have. Retail traders are an important
part of any financial market, so if they consistently lose money, it eventually
causes problems for that market. If more option traders learned technical
analysis, the option markets would be stronger, because when more option
traders are successful, more traders will want to trade options.
That was really the point of my May 2008 article. Thank you for writing
and commenting. I hope I have clarified any statements that readers could
have found confusing.
TEMA HEIKIN ASHI CODE FOR THINKORSWIM?
Editor,
I am interested in getting code for the moving average crossover
discussed in the May 2008 S&C ("The Quest For Reliable Crossovers"
by Sylvain Vervoort) for the thinkorswim platform. Please advise.
Jibin Thomas
Try contacting the company's technical support for code. Unfortunately,
we are not able to provide techniques for all the various platforms.--Editor
THE QUEST OF RELIABLE CROSSOVERS
Editor,
I look forward to reading your magazine each month. I found the
article "The Quest For Reliable Crossovers" in the May 2008 issue of STOCKS
& COMMODITIES to be very interesting.
However, I was disappointed to find I was not able to run the
strategy for reliable crossovers using the code provided in the Traders'
Tips section for Wealth-Lab Pro version 5.0. I copied and pasted the code
directly from your website into Wealth-Lab Pro 5.0. The program generated
several errors and, after communicating with the programmers at Wealth-Lab.com
about the script, I found out that the TEMA indicator is not available
in version 5.0 of Fidelity's Wealth-Lab.
I would like to have a version of the strategy that works with
Wealth-Lab Pro 5.0 or 4.5.35. Would this be possible?
Cheryl Semff
Thank you for writing. In our monthly Traders' Tips feature, the code
is provided by the software developers themselves, not by us, and unfortunately,
we do not have the resources to perform individual programming tasks. In
the case of the May 2008 Traders' Tips column, in the Wealth-Lab contribution,
the version used appears to be Wealth-Lab Pro 5.1, judging by the screen
capture in Figure 5 on page 71.
I would recommend that you communicate with other Wealth-Lab users via
their forums to see if others experienced similar problems.--Editor
ERRATA: JUNE 2008 TRADERS' TIPS
The captions that appeared beneath the Aspen Graphics figures in the
June 2008 Traders' Tips section were incorrect. The correct captions are
as follows:
FIGURE 12: ASPEN GRAPHICS, ETF TIMING MODEL. Here is
the Gardner timing model overlaid on a candlestick chart of IGM. It displays
the bars on which to enter and exit a position, as well as the price points
for setting the limits.
FIGURE 13: ASPEN GRAPHICS, ETF TIMING MODEL. Here is another
way of looking at the same time period for IGM. An Aspen color rule is
used to indicate which bars offer good entry and exit points according
to the timing model.
We regret this error.--Editor
