Transcript Long Diagonals - Kirkland Traders

Long Diagonals
Better rewards and lower risks
while
Requiring Directional Movement
The Haley Diagonal is simply a
covered call on Steroids
• Using options for the long component decreases the
cost and / or increases the leverage.
• Rolling the shorts leverages technical moves.
• Rolling the long provides capital growth while
decreasing the risk if direction reverses.
The trade:
• Is Both a Fundamental AND technical trade
• Can be played Bullish or Bearish
– Requires an Intermediate or Long Term Posture of one or the other
– Allows for some stocks to be bullish while others are bearish
– ETFs can work, rewards and risks are lower
Definition of Success
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Follow investing Plan
Protect and preserve capital
60-70% of trades are winners
Make a minimum ROI of 50% per trade –
Losses under -10% ROI
• Plan Income vs. Capital Gain (trade 1
month vs. several months) and manage
accordingly
Watch List Criteria
• Bearish
– Stocks already in a bear watchlist
– Market Posture Bearish or neutral – for anticipated
length of trade
– Poor Fundamentals, industry group under 40, ACC/
DIST < 40, downtrend on 30 DMA
• Bullish
– standard InvesTools Bull stock fundamentals. Phase
1 and 2 scores…
– Bullish posture on Industry and / or Geography if not
a broad ETF
Bear Entry Rules
• Stock price expected to continue to trend down or
sideways for the duration of the trade
• Consider legging into the trade. Enter the long side as
the Stock price bounces down from resistance and the
MACD rolls down. Enter the short side when the price
bounces up
• Confirmation for naked entry is at least two days of trend
• Enter short as MACD rolls up 2 days in a row, preferably
before green arrow appears (this is a bullish signal,
because your short is to protect your bear trade in a
bullish swing)
Long Option – IT Market Matrix
• First buy the long option deep ITM, with delta -0.71 to -0.73 for Puts,
or.73 -.75 for calls. Use IT deltas such as on the Market Matrix– DO
NOT USE TOS Option chain deltas – they are different and will
affect the trade risk VERY GREATLY. The TOS default for
“Volatility Strategy” is “Individual Implied Volatility” which should be
used for Verticals and close calendars. If you must use TOS,
change “Volatility Strategy” in Setup (upper right corner of Monitor
Tab) to “Volatility smile approximation.” This will make the
Theoretical price calculation in TOS vary greatly from the mid-price
calculation of Bid and Ask that most users depend on. In TOS you
can not have theoretical price and deep ITM deltas both correct at
the same time.
• Buy the long option 3-4 months out. In a Bear market, make sure
that if the trade is entered near earnings, the expiration of the long
option has the same relationship to earnings. This helps manage
the Vega risk.
Long Option –
TOS Individual Implied Volatility
• First buy the long option deep ITM, with delta -0.7 to -0.75 for Puts,
or .69 - .72 for calls. These are the numbers I used in a short (4
month, 100 trades (long count)) experiment. I used the TOS default
“Volatility Strategy,” “Individual Implied Volatility”. There are
significant roll differences mentioned later.
• Buy the long option 3-4 months out. In a Bear market, make sure
that if the trade is entered near earnings, the expiration of the long
option has the same relationship to earnings. This helps manage
the Vega risk.
The Shorts
 Sell the short side OTM, with delta 0.28-0.32. The short is either the
current month or the front month if near term expiry is less than 21
days. The difference between the long and short delta should be
around 0.4 at this point.
 The difference in deltas provide the risk management for avoiding
delta inversion where the near term delta exceeds the long term
delta and even with the direction right you start to lose money.
 If you can’t get a short with the right delta, you can pick a higher
delta strike and sell fewer of them to keep the ratio similar.
Trade Management
InvesTools calculated Delta
• Rolling is the key to making a profit in a Diagonal Spread
– Buy back the short option and sell another at any point if the value is now 20% of
what you sold, or 33% if the value drops very rapidly (a day or two) or reaches .10.
All these are due to the underlying ticker moving agaisnt your posture. You should
also be watching to see if your posture is wrong.
– Buy back the short option if the delta decreases by 0.2 or more
– If the short delta goes above .65 or within .15 of your long delta, roll it down. This
happens when the ticker is moving in the direction you want, but faster than you
might like. You are making money here, do not panic, this is good!
– If the underlying is moving away from you (against the long), sell another short!
• If the underlying is trending strongly in your long option’s favor, leave it
uncovered until the price bounces – Confirmation of bounce is 2 days change
in direction.
• When selling a new short option, use the same delta calculator you used
to enter the trade and review the delta of the long option. Make sure the
new short is about 0.4 from the delta of the long option
• Roll the long closer to ATM when the delta gets to ~-.95 (Bearish) or .95
(Bullish). If the trend looks to be continuing, roll out to the next expiry that
has the same relationship to earnings. Select a new strike with a delta of
approximately -.73 -- -.75. You will either get several months additional time
for no cost, or additional contracts for no cost, either way allowing more
shorts to be sold for the duration.
Exits
• Monitor position daily
• Exit if trend definitely reverses (e.g. breakout with
volume after news, etc), broken support / resistance, etc
• Losing trade may be exited early when the spread has
lost 50% amount of its opening value - discretionary. If
confident of direction, consider “rolling” with the punch
and selling shorts closer to new ATM value – potentially
all the way to a calendar
• In the last month before expiration of the long option,
consider the final exit. Aim to exit at least 2 weeks before
expiration to avoid maximum theta decay on the long
side. The final trade may be a vertical, or just sell the
long option
• If the trend is continuing, roll long out.
Money Management
• Re-enter short position as frequently as possible
to generate highest possible returns
• Position-size for a debit trade. E.g. if 1% total
portfolio risk is acceptable, enter the trade
calculating a 50% max loss to be no more than
1% of the total portfolio – for $100,000, this
would be a $1,000 max loss.
• Final profit is calculated by adding the final credit
for the long option to all of the net credits from
selling the short options, then subtracting the
entry purchase price of the long option.
CROX Trade – Whatever goes up oddly, may come back down rapidly.
POT Trades -- sometimes I screw up a good thing
The numbers are still good, even with screw up
I had to
manipulate
prices a bit to
represent what I
actually traded,
Thankback was
reasonably close
on most
ROI is 583%
Over 6 months
Including
commissions
But not taxes.