
# One Easy fix for traders getting stopped out too early or cutting profits too soon

If you’ve traded actively for at least a few months or years, you’ll know all too often the agony that comes
with getting stopped out of a position and immediately, the trade takes off.
A similar but lesser form of agony is felt when a trade has hit your price target and you proudly sell your position.
Except, it keeps going and going...

:::cut:::

I know I’ve felt these emotions more times than I can count.
If only there was some magic indicator which would give me the expected range of the overall market,
I could better set my stop loss and profit taking levels.

Fortunately, I eventually figured out that the VIX index is a simple and solid indicator for this.
[What is the VIX index?](http://www.investopedia.com/terms/v/vix.asp)

I instinctively check VIX throughout the day to make sure it is within "normal ranges" when putting on and taking off trades.
Just take a look at the below chart:

![](chart-1024x588.jpg)
Figure: Data: January 2, 2004 – December 16, 2016

Whenever the VIX is under 17, the S&P500 daily range averages less than 1% (High of day minus Low of day).
And most of the time the VIX is under 14, the S&P500 range averages less than 0.7%.
However, when the index is trading close to 17 or higher, more extreme moves in the S&P500 can be expected with much greater predictability.

Here is a breakdown of the graph in table format:

| VIX Values     | S&P 500 H-L Averages | # of Occurrences | %age of Occurrences |
| -------------- | -------------------- | ---------------- | ------------------- |
| under 11.01    | 0.61%                | 92               | 2.8%                |
| 11.01-14.00    | 0.74%                | 919              | 28.2%               |
| 14.01-17.00    | 0.96%                | 793              | 24.3%               |
| 17.01-23.00    | 1.22%                | 768              | 23.5%               |
| 23.01-30.00    | 1.78%                | 397              | 12.2%               |
| 30.01 and over | 3.35%                | 295              | 9.0%                |

Even traders who do not trade options must pay close attention to the VIX index to avoid exiting positions too early and getting whipsawed.
Equally important, when volatility is low, don’t expect big moves especially in names highly correlated
to the S&P500 index in terms of direction and beta.
In low volatility environments, you must take profits earlier and keep a tighter stop loss.

Here, we’ve provided an easy way to roughly gauge the market ranges for the day, but we could of course dig much deeper.
For instance, we could combine volume, sector and many other factors
in our analysis and come up with more accurate measures of range not just for the overall market,
but also for certain sectors and stocks.

Perhaps, in the future, this analysis will come, but for now, pay attention to the VIX.

Until next time….Always stick with your risk limits and Happy Trading!



# Day trading options

The term “day trading” assumes that a trader opens and closes positions within a single trading session and doesn’t take positions overnight.

Also, when talking about day trading, people generally think of instruments such as – equities, ETFs and futures. Not options.

However, let’s analyze whether we can use options for day trading and, if so, we should consider how to adjust trading styles
and which nuances to focus on while trading options within such a short time frame.

:::cut:::

## Day trading requirements

First, let’s consider which conditions an instrument must satisfy to be traded within a day without taking positions overnight.
The most important are:

- Relatively high volatility
- Enough liquidity
- Acceptable commissions

Volatility is required to allow a trader to catch a relatively large price move.
Certainly, we could say that volatility may be “scaled” if an instrument can be traded with leverage,
but in this article, we consider non-leveraged trading.

Liquidity is required to allow a trader close his position at any moment with a tight bid/ask spread.
When analyzing liquidity level, we must take into account the size which we trade.
If we trade only one contract, then liquidity is not an issue in most of the instruments you might want to trade.
Besides the quantity of contracts which you can buy/sell in any given moment, an important metric is the size
of the spread between best market orders. You pay half of the spread to the market each time when buying/selling at market price.

Commissions is not only an instrument property as it mostly depends on your broker/FCM.
The only requirement is that commissions must not kill a significant part of your profit.

Now let’s take a look at whether options satisfy these requirements.

## Options price volatilities

The heading above is a bit misleading for anyone who knows something about the implied volatility concept.
This paragraph is not about IV/HV of an option’s underlying instrument; it is about the volatility of the option’s price itself. Here we are considering options not as a derivative, but as an independent security.

To start, let’s take three options on the S&P 500 futures index, which are being traded at the moment of writing this article.
We consider three options, one is at-the-money, and two (call and put) are out of the money.
For each of the options, we build a candlestick chart for daily prices from the beginning of the instrument’s lifecycle to the current day.
We can see on the chart that price movements are significant, sometimes moving more than 100% in one day.

![](cnds_4months-1024x576.png)
Figure: ES mini 2200 put and call daily prices, 4 months

Now let’s build the chart for intraday data, 10 minute periods:

![](cnds_1day-1024x576.png)
Figure: ES mini 2200 put and call prices within one day

The day was selected randomly, 2016-11-22.
It’s easy to see that the price range of the put option for this day was between 22 and 27.5 points or more than 20%.

In other words, the option’s price changed significantly more than the underlying’s.
Therefore, options price volatility is more than enough to allow traders to use them as a speculative security for day trading.

### Note

The charts above were built for option strikes which now are at the money.
If an option is far in or out of the money, then it’s price will not be so volatile.

## Options liquidity

Liquidity of a single option is always lower than the liquidity of its underlying. There are several reasons for this.

1. The number of options is bigger than the number of underlyings by thousands of times.
   For example, right now (when this article was written) there are 6 options series for the ES mini December futures.
   Each series contains about 400 options.
   Even if we assume that the number of people who trade options is equal to the number of people trading futures (the underlying),
   their interest is dispersed on all the different options.
2. In reality, the number of people who trade options is much fewer than number of traders for linear instruments

### Near the money liquidity concentration

The further the strike is from the money, the less liquidity exists at that strike.
If we open a big position in an ATM option, we must remember that it might become harder to close that position
if the underlying price changes significantly causing the option to be far in or out of the money.

To demonstrate this let’s visualize some data from the CME Group website.
This is a time and sales report, a simple table containing the following columns:

- Trade time
- Trade instrument (call/put and strike)
- Trade price
- Number of contracts in trade

We want to understand at which strikes the most trades are concentrated.
The best way to visualize such kind of information is a histogram.
We’ve built two: the first shows a distribution of the number of trades,
while the second illustrates a distribution of the number of traded contracts.

![](strikes_hist-1024x576.png)
Figure: Number of trades per strike in one day

As expected, most trades occurred near the ATM strike. The black dashed line on both charts denotes current underlying price.

But since we are talking about intraday trading, it’s not likely that the liquidity of a particular contract will change significantly in one day.

### Spreads

What really can affect the performance of intraday options trading is the bid/ask spread.
Let’s compare the spread of the underlying (ESZ16 futures) with that of the corresponding ATM call option.

Right now the spread in ESZ16 futures orders book is 0.25 or 12.5 $ and this is equal to the minimum price step,
denoted in contract specification.
Contract nominal value at current price is 2200/0.25\*12.5 = $110,000. The spread in futures then is equal to 12.5/110000 = 0.011%.

[http://www.cmegroup.com/trading/equity-index/us-index/e-mini-sandp500_contract_specifications.html](http://www.cmegroup.com/trading/equity-index/us-index/e-mini-sandp500_contract_specifications.html)

On the other hand, the current price of an ATM call for this futures contract with expiration in two weeks is about 16 points.
Price step of this contract is also 0.25 = 12.5$.
Spread can’t be less than the price step.
Thus minimum bid/ask spread is 0.25/16 = 1.56%, which is huge in comparison to the spread for its underlying futures contract.

## Commission

Commissions are mostly a property of the brokerage firm, not the contract.
In our understanding, commissions must be at least smaller than half of the contract’s price step.

## Day trading options, conclusion

Near the money options can be used as a speculative instrument for intraday trading.
When selecting the appropriate contract, it’s worth it to pay attention to the following things:

- average size of the bid/ask spread
- how far an option’s strike is from underlying’s price; always try to select ATM option for best liquidity
- how many contracts traded per day on average



# How to read P&L Charts (part 1)

The question considered in this article might seem too obvious, and one might say that there is nothing to discuss.
But our user support experience tells us that often people who are entirely new in options spent excessive time
on trying to figure out options payoff profiles.
Having a well-developed skill of reading options risk profiles (alternative terms are P&L profiles, payoff function profiles) is essential to successful options trading.

For sure, sooner or later everyone will understand all the details, but we think that with this article we may accelerate this process.

:::cut:::

## P&L of a position in a linear asset. Numbers.

First, we assume stocks, bonds, indexes, commodities, ETFs and even futures are all linear assets.
They all (except futures) have their “own price,” which doesn’t directly (formally) depend on any other asset.
Futures price depends on its underlying asset price in a linear way, thus we also assume futures as a linear instrument.

Assume you have $100 in cash.
You then decide to buy a stock with a current price of $100.
Therefore, your portfolio will consist of 1 share, and you will be glued to computer/smartphone monitoring the price of the stock.
What you are doing is simple and straightforward.
You just observe the price, and since you have only one share, you know that the value of your portfolio entirely coincides with the stock price.
Then you simply compare the current value of the portfolio with your initial investment ($100) to calculate your P&L.

## Putting the numbers on a chart

Now let’s put the example above on a chart. Let’s take a look at figure 1.
The x-axis is the per share price. The y-axis denotes our portfolio P&L
The chart we are going to build shows the relationship between the P&L and the stock price.

![](fig1.png){.thumb}
Figure: Fig. 1, P&L of 1$ price movement up and down

The blue point corresponds to the very moment when we’ve just bought the share.
Price at that moment is $100, and therefore the P&L is zero.

If the price moves from $100 to $101, then our portfolio will be worth $1 more than the initial cash amount; thus, the P&L is $1.
The green dot on figure 1 corresponds to this scenario.
Its coordinates on the plot are $(x;y) = (101;1)$.

On the other hand, if the price goes down to $99, then the P&L will be -$1; the red dot on the figure corresponds to this scenario,
its coordinates are $(99;-1)$.

Similarly, with a bigger price move of let’s say, $2 instead of $1, we can see that On figure 2,
the stock price changes to $102 (green dot) or $98 (red dot).

![](fig2.png){.thumb}
Figure: Fig. 2, P&L of 2$ price movement up and down

Moving onto figure 3, we see that all the points are lying on a straight line.
No matter how much the share price changes, the P&L points on the chart will always be lying on this line.

![](fig3.png){.thumb}
Figure: Fig. 3, All dots are lying on a single line

This means that P&L has a linear relationship with the price.
In teenager math form, this would be $y = Qx$, where $y$ is the P&L of the portfolio, $x$ is the stock price change, $Q$ is the number of shares

The P&L of the portfolio is the number of shares multiplied by the P&L of a single share. Therefore, we can substitute $p - p_{0}$ for $x$,
where $p_{0}$ is the purchase price (for a long position) and $p$ is the current stock price.
We can now rewrite the formula as:

$y = Qx = Q (p - p_{0})$ **(1)**

This equation describes the direct dependence of the portfolio P&L on the share price.

What if we own 2, 3, etc. shares?
The $Q$ in the formula above will be $Q = 2$ or $ 3 $ so $y = 2(p - p_{0}), y = 3(p - p_{0})$ and so on.

On figure 4, we’ve added the line corresponding to a portfolio of 2 shares.
Note the angles between the P&L lines and the x-axis.
The more shares in the portfolio, the bigger angle is, and the faster you earn or lose money.
For 1 share, the portfolio P&L angle is 45 degrees, while for two shares, the angle is 63 degrees.

![](fig4.png){.thumb}
Figure: Fig. 4, Different angles for different position sizes (number of shares in portfolio)

## Changing the open price

In the example above, the stock was bought at $100.
What would the chart look like if the position was purchased at $99?
How do we redraw the P&L line? The line will be the same as before, just shifted to the left by 1, as shown in figure 5.

![](fig5.png){.thumb}
Figure: Fig. 5, Different open prices

## Closing the position

What if the stock price rose to $101 and the holder decided to sell it and close position? What will our chart look like then?

We can think of selling the position as a separate short position and draw them both on the chart (figure 6).
When you buy and sell a security intraday, your broker actually keeps both positions separate.
In effect, you own both the original long and the offsetting short – even though you only see cash.
Only after the trades are settled and cleared, are these positions will be collapsed on your broker’s books.

![](fig6.png){.thumb}
Figure: Fig. 6, Short position

For a short position, the $Q$ in our equation (1) is negative, $Q = -1$.
Thus, the P&L for a short position is $y = -1(p - p_{0})$ and its chart is shown in figure 7.
Since this is a short position, $p_{0}$ represents the sold price and $p$ still represents current price.

The total P&L of the portfolio, green line, is the sum of the red and blue dashed lines on the chart.
Literally we need to sum red and blue lines at each point.
The green line is, therefore, a constant, regardless of how the price changes going forward as the sum is always 1.
The position is closed and we have a $1 profit in cash.

![](fig7.png){.thumb}
Figure: Fig. 7, Total P&L of closed position

The beauty and usefulness of P&L charts are that you can quickly estimate your P&L no matter where price is going.
You see the whole picture in one chart.

Examples considered in this article are simple, but using them, we’ve explained the basic principles of building P&L charts.
Understanding these concepts will be essential when we explain more advanced options concepts in future articles.


Blog #futures

One Easy fix for traders getting stopped out too early or cutting profits too soon…

Day trading options

How to read P&L Charts (part 1)

Last thing