August 19, 2017

Friday’s Market Stance and Quick Options Primer

Okay, that had to be one of the most uneventful weeks of the year.

The S&P 500 (SPY) closed the week completely flat. Great for those of us who sell credit spreads, but horrible for the directional traders out there (time decay is their enemy).

As for the Dow and Nasdaq, they moved opposite directions. The Dow advanced 1%, while the tech-heavy Nasdaq 100 lost -1% thanks to the recent declines in Apple (AAPL).

As we head into next all but the Nasdaq 100 (QQQ) is in a short-term overbought state. Couple the overbought readings in the major benchmarks with a plethora of extremes in the other highly-liquid ETFs I follow and you can quickly see what side I will be leaning towards as we head into next week.

Quick Options Primer

I am often asked about how I come up with the probability of success percentage that I refer to in many of my reports and articles.

For those of you new to options, and more specifically selling options with a high-probability of success I encourage you to delve into what, in my opinion, will be the wave of the future for investors.

So, what do I mean by a high-probability of success.

The answer is quite simple.

Take a look at the following options chain:

If you look at the far left side of the options chain you will notice a percentage-based number. This is the “probability of expiring” out-of-the-money or the probability that the underlying, in this case SPY, will close below the given strike.

For example, if you look at the Jan13 86 strike you will notice that the probability of SPY expiring below 86 (out-of-the-money) is 84.48%. That means that if I sell this strike, the chance that SPY will close below the 86 strike is roughly 85% with only 41 days left until January expiration. The closer I move towards the at-the-money strike the lower my probability of success or the higher the probability of the underlying expiring above the chosen strike.

A fairly easy concept to grasp.

This is the one of the first steps in choosing which strikes to use for your credit spreads and arguably one the most powerful tools for the future of investing.

If your trading platform does not have options theoreticals, you can use the delta as an approximation. Just take the delta minus 100 and you will get a rough estimation as to what your probability of success will be on a credit spread trade.

Again, I will discuss this further over the coming days, so stay tuned.