options.txt

__Profiting.from.Weekly.Options.How.to.Earn.Consistent.Income.Trading.Weekly.Option.Serials.pdf

page 76

The 103 call and the 104
put have intrinsic value, but they also have the same amount of air as the 104 call
and 103 put. In either case, as we move up and down they will become all air and
the ATM straddle will be the sum of the 104 call and put plus the sum of the 103
call and put divided by two. This formula will work for any ATM that is currently
between strikes!

page 77

The ATM straddle will be the sum of the two out-of-the-money
options + the sum of two in-the-money options ÷ 2. This formula will
work for any ATM that is currently between strikes!

page 88

To figure the premium in any strike, subtract the intrinsic value from
the current price and it will give you the premium left in the strike.
Both the put and call will have the exact premium, plus or minus the
bid–offer spread.

page 89

Days until Expiration is a composite of the most likely premium levels on any
given day for the final 14 days of the 50 most liquid stocks that are priced over $50.
I believe that this table is the only one to be printed, and it will give you the highest
probability of premium levels on any given day. As you can see, even on expiration
Friday of May2 14 AAPL 590 call will still be worth 2.90 (50 percent of the straddle)
if it is at the money.

This provides a more realistic indication of risk at expiry.  

[do this for the weeklies as a reference]

page 91

credit spread, aka vertical spread - selling an option closest to the at-the-money (ATM) strike price
and buying one that is further away.   The reward
is limited to the difference between the strikes initiated minus the
premium collected.

Call Credit Spread (Bear Vertical)
Put Credit Spread(Bull Vertical)

page 94

It is called the 60/40 because the deltas that are used are the 60 delta option and the 40 delta
option. Usually, this is going to be the ATM +1/−1 but it could vary slightly. A
good rule of thumb is to never use more than the ATM +2/−2, regardless of market
conditions -  this spread is more aggressive in
nature because it is only used when you want to press your advantage -  if you
have done a good job in projecting the price action, it is a much bigger winner -  if the underlying price
stays where the spread is initiated, it will no longer be a winner; it will be a scratch,
because we are buying as much premium as we are selling

Using our conversion and reversal formula you should know that the premium
(air) at any strike in the same serial is always equal +/− the bid offer spread - Using our conversion and reversal formula, you should know that the premium
(air) at any strike in the same serial is always equal. 

Call Credit 60/40 Spread (Bear Vertical)


page 96

Risk Reversal (Synthetic Long Stock) - purchasing a call and selling a put simultaneously at the
same strike -  limit our risk to the downside: buy an out-of-the-money put

buy more intrinsic value so as not to finance a great amount of premium - 
buy the ATM −4 call and sell the ATM −4 put, buy the ATM −5 put for protection.

page 97

Risk Conversion (Synthetic Short Stock)

put risk reversal, known as a conversion. It is called a conversion because we are taking the options and
‘‘converting the stock to a short position.’’

executed by purchasing a put and selling a call simultaneously at the same strike. This creates a synthetic underlining sale of 100 shares of stock, limit our risk to the downside with buying an out-of-the-money call.   buy more intrinsic value so as not to finance a great
amount of premium - buy the ATM +4 put and sell the ATM +4 call, buy the ATM +5 call for protection

page 98
Call Backspread (1 by 2 for Even)

has unlimited reward and limited risk, but has many of the benefits of the 60/40 credit spread in
that the risk is limited to strike prices. The major difference between the two trades
is that it has unlimited reward.

 traders shy away from this type of trade because they fear the risk of
getting pinned at the 600 strike on expiration. This is a valid concern; however,
earlier in the chapter I talked about estimating the premium in the model at any
point in time prior to expiration. Table ‘‘Days until Expiration’’ shows that the
AAPL ATM straddle on the morning of the Friday expiration should be trading at
approximately 3.80, and that means if we are trading at the 600 strike that morning,
the call should be trading around 1.90.

Put Backspread (1 × 2 for Even)

  In most cases, no matter what strikes you use,
the risk will be close to the value of the strike spread.

You should have noticed
by now that no matter what strikes we use to do the 1 × 2, as long as they are
touching, such as ATM −1−2 or ATM +3 +4, if our short strike is at the money,
we should still be at or near a breakeven position on expiration Friday. The key to
this trade is managing the risk on Friday. Of course, if it is a big winner; all that is
necessary is to take off the spread and sell the ITM money before the close.

page 108

risk/reward

the risk/reward in a credit spread, this trade would
risk $2.80 to make $2.20; it has better than a 2/3 risk/reward ratio and will be
a key number to initiate trades.

page 111

Backspread (1 × 2 for Even)

the problem with trading such a high-priced stock is the spread
that must be employed, because the premium in each strike is so large that you
can’t use touching strikes. The 1 × 2 is not conducive to this type of environment. Although
theoretically it is exactly the same as trading smaller stocks, the big dollar risk doesn’t
make this trade practical unless you have a large amount of risk capital. The bigger
the strike risk, the less you want to use this strategy.

page 112

Weekly credit spread, 60/40 credit spread - will fit with any stock as long as you can maintain
a 2/3 risk/reward ratio... use the ATM +1/−1 or the
60/40. It is a Vega-neutral spread, and it employs the 60 delta and 40 delta
options.

Risk reversal synthetic long or short - 
Once you move to the higher-priced stocks, you must go to the synthetic in
order to overcome the premium. Although the option model works the same
for higher-priced and lower-priced stocks, the dollar risk comes into play, and
since our goal is to minimize the dollar risk and maximize our leverage, you
must use the risk reversal on high-priced stocks.

backspread (1 × 2 for even) - works very well in modestly priced stocks where you can use
touching strikes. As you move further away from the ATM, the chances are
less that you have to cash this trade. In higher-priced stocks, the strike risk
becomes too large, and I suggest that you abandon this type of trade.

page 118

 Sellers of credit spreads
have limited risk and limited reward. However, they win three ways if the price
stays where the spread is sold, if the price goes in their predicted direction, or if
the price moves against them by less than the credit received.

page 128

the price
of the liquid asset will rotate around the mean price roughly +/−65 percent of the
time, or approximately one standard deviation on either side of the mean, and I call
this congestion.

page 130

The mean is the middle of the congestion phase and the double tops and
bottoms are +/−1σ on the left and right of the mean. The reason that the markets
remain in congestion is that the uncertainty about the direction of the current price
causes the strong hands and weak hands to constantly change dominance until one
of them overwhelms the other and the market breaks out. 

represented by +/−2σ, although the time that the market is in congestion is much longer. 
The distribution of price occurs after we ‘‘break out to the trend,’’ and this is also consistent 
with what happens when the strong hands are able to force the weak hands out of the market.

If the new strong hands begin to run over their
opponents, the market will go +/−3σ and the blowoff will occur.


 It can go from one congestion pattern to another without a trend. It can go
from one blowoff to another without going into congestion or a trend. Or it can go
through the normal cycle, which is congestion, breakout to the trend, and then the
final blowoff.

When I am trading and the market is moving around, I am constantly thinking
about the distribution curve. As we roll from one strike to another and the premium
levels change, I think of the ‘‘Days until Expiration’’ table in the back of the book to
anticipate what will occur if the market goes into congestion at any time. Congestion
is always the toughest phase to trade. I am a reactionary trader, but once I take a
trade, I become a predictive trader, and, as such, I need the market to respond in
the direction that I have chosen.

Going back to your distribution model should give you some
comfort; if the market is in congestion, you can see where the next opportunity
should appear. If it is trending, it will help you to continue with the trend. Finally,
when you are in a blowoff situation and the greed is overwhelming you, it will give
you the confidence to take the winner off and look to reverse at a time when many of
your opponents are making the classic mistake of selling a blowoff bottom or buying
a blowoff top.

page 133

use two time frames for managing trade

Generally, the first trade I make in a congestion pattern is a loser. I am not able to
see the support and resistance levels that are forming until a double top or bottom is
hit and the strong and weak hands change ownership. 

page 137

Another reason not to use
the parity options is because your risk will mimic the underlying. Even though you
still have limited risk, if you buy an option near parity and get a big move against
you, it will lose almost as many deltas as the underlying stock, giving you a nasty
black eye.

Buying an outright call at a double bottom gives you a nice shot at a winner.
First, you have support that is close by, and if necessary you might even add to
this trade at support. Second, there is some volatility, and with the price angle
accelerating it has a good chance to advance to the mean +1σ very quickly. When
the shortest technical time frame you are observing gives a buy signal,
initiate the trade

. Your only adjustment would
be to ‘‘roll up or roll back.’’ I never roll up until the new ATM is at least
four strikes above my current long call. I like to roll up to limit my intratrade
risk. I am willing to pay the premium to make sure that in case of a sudden move
against me, I don’t mimic the underlying asset tick for tick on the way down.

 if the bottom below is violated by a certain small
percentage or my shortest indicator tells me to take my loss, I am out of the trade.
I know that there will probably be some price action around the low of the current
move. I anticipate that, and so I always allow a few ticks below that low to stop
me out. Sometimes it works; other times I end up selling the low of the move.
The important thing is that you make the same trade each time; nothing works all
of the time. I will stay in the trade until I reach the other side of congestion, and I
will look to reverse and get short if the double top holds and my shortest technical
signal gives me a reversal signal. If the market takes out the double top, I will
stay with the trade, as it could turn into a monster winner if the new trend is to
the upside.

page 138

Buying an outright put is the exact mirror image of the outright call. The only
difference is that it is initiated at the double top.

The strong hands, which
have been the longs, cannot push it past +1σ and the short hands, which have been
on the defensive, take control.

As long as the trade goes in your favor, let the trade run. Your only adjustment
would be to ‘‘roll down’’ or ‘‘roll back.’’ I never roll down until the new
ATM is at least four strikes lower than my current long put. I roll down
to limit my intratrade risk. 

page 139

A double bottom is a great spot to sell a bullish credit spread. You have support
right below, at the nominal double bottom, and you have plenty of price room to
the previous high; the market has some velocity to the upside. Check to see if you
can get the 2/3 ratio that we want when we sell a credit spread. 

page 140

 If you are more aggressive, you could consider
the 60/40 spread and see if you can do it ‘‘Vega neutral.’’ That means that you are
collecting a credit equal to or greater than the debit in terms of air, not nominal
price. If the spread expires here, it will be a scratch or near it. Unlike the ATM
−1 put spread, we do not make money if the price doesn’t change; the best we
can do is scratch the trade. The 60/40 gives us more upside if we are correct; it is
more aggressive, because we can only make money if we have correctly predicted
the direction of price

If the market rallies after you initiate the bullish credit spread you must still manage
your winner. You can do nothing and allow the spread to expire worthless, or if you
are more aggressive you can roll it up. Similar to the outright buy of a call, I never
do anything until the price advances to at least ATM +4 from my short leg of
the credit spread. Sell the ATM +4 +3. If you are aggressive, you can let the
old spread stay on the books, as you are now a very big favorite to cash the trade. If
you are conservative and are concerned about a sudden reversal of fortunes, you can
buy back the short leg of the original spread. I prefer to leave the long leg on, as it
is probably near to being a teenie and could turn into a lottery ticket. Never sell
the long leg and hold the short leg, as you will create an unlimited risk
situation. As long as the market goes in your favor, continue to roll the spreads up
for maximum possible gain.

On Friday, I roll back the bullish credit spread by first selling the new ATM/ATM
−1 in the next weekly or the 60/40. I only buy back my existing spread if it is in
danger of going out as a loser. If it is beyond the expected range, I will leave it
in place. Even if the market starts to move against me that late in the week, I can
always take the expiring spread off. Many times it will be so far out of the money
that even adverse price movement will not affect the trade.

page 141

I said I don’t try to scalp around trades, but I do take a defensive posture by selling
another credit spread on the other side of the market. That will turn the original
position into an iron condor. I don’t use iron condors to initiate a spread, because
you must pay double commissions and double the bid–offer spread, but I will use
them to try and scratch a losing trade.

page 143

manage winners is pretty simple: As long as the market continues to break
I let it run until the trade runs into support. If the support doesn’t hold I will roll the
spread down and continue to do that until I have a losing trade.

risk reversal is the first aggressive spread trade that you can make. Your risk in
this trade will be the same as an outright buy from a price perspective; however,
by using the premium in the put you will diminish the premium risk. The trade
will be initiated when the shortest technical time frame that you are observing turns
positive. I like to use the ATM−1 for this trade because it has less air to be offset
by the put. Margin is always a consideration, and to offset the margin problem I buy
the outright call first and then I sell the put spread.

The trade is aggressive, and if the underlying
stock begins to break, initially we will lose money tick for tick. However, your risk
is limited to the price of the call plus the loss in the put spread.

page 144

Rolling Up a Synthetic Long
I will roll up if the ATM moves more than two strikes to the upside. I sell a vertical
call spread, replacing my old ATM −2 with a new ATM −2. I don’t need
to replace the put spread because it is a winner, and I use it as a means to finance my
new call premium. If you want to reduce the premium risk to zero, you can sell the
new ATM −2 −4 put spread, but you don’t have to. If you don’t mind having a little
more intratrade risk you don’t have to roll up. I roll up to reduce my intratrade risk,
as my protection from the put spread is now closer to my long risk reversal. I roll
up to guard against a wild opening to the downside. I want my protection closer to
my long. When I roll up, I already have booked a $5 winner and I am now long with
a premium risk of about $4. I believe that not rolling up when the ATM goes two
strikes in your favor is a mistake; however, many very successful traders might argue
the point, as you are probably going to give up some liquidity by paying the extra
commissions and breakage. If the trade continues to go in your favor, you give up a
little bit of premium, but if the market gaps against you, it will still be the winner.

Rolling Back a Synthetic Long
On Friday, I roll back the risk reversal by first selling the horizontal call spread. In
this trade, you must sell your long call and buy the next weekly serial ATM −2 call.
After the roll is in place, I sell the ATM −2 −4 put spread. Unless the trade is going
badly and my expiring ATM −2 −4 put spread is in danger of going in the money, I
let it expire worthless. If it is close, you will have to monitor it. My rule is, when in
doubt, cover and go on to the next trade.

Managing Risk in a Synthetic Long
As with all limited-risk trades, I can get out if the bottom below is violated by a
certain small percentage or my shortest indicator tells me to take my loss. I am out
of the trade. This trade is managed similar to owning a call outright. There will
probably be some price action around the low of the current move; I always allow a
few ticks below that low to stop me out. Exactly what measure you use is up to you,
as long as you limit your risk. The important thing is that you make the same trade
each time. I will hold the trade until I reach the other side of congestion, and I will
look to reverse and get short if the double top holds. If it doesn’t hold, I will allow
my long to run, as we may be having a breakout to the trend on the upside and I
have a great head start.

page 145

Risk Reversal (Synthetic Short)
The synthetic short is actually called a risk conversion because you convert the long
stock into a short stock position. I will use the term risk reversal for both the
long and short positions, as the mechanics of execution are exactly the
same. The synthetic short is a mirror image of the long trade. The difference is that
since you are initiating a short position, you must think in reverse. You will now
buy the ATM +2 put and sell the ATM +2 +4 call spread. The rest of the trade is
managed exactly the same as the synthetic long.

The biggest edge using the short risk reversal is that it allows you
to short the stock, with no FINRA restrictions. When you hear about large
hedge funds shorting stock, it is almost always through the options. If they are wrong,
their risk is limited, and if they are correct, they get the stock through exercise.
Additionally, they are not subject to the short-selling margin. Unlike a synthetic
long, they have reward limited to the stock going to zero, so technically it is not an
unlimited reward/limited risk trade.

page 146

Bullish Backspread (1 × 2 for Even)
The final trade that I do is the backspread. When the shortest time frame that I am
observing gives me a buy signal, I initiate the trade. This spread can be tricky and
needs to have the right amount of air in the balloon or my strikes may be too wide
to use it properly. During periods of very high volatility, I don’t use this
trade; I use the risk reversal or an outright buy. 

The risk is somewhat mitigated by the fact that even
with as little as 1 hour left until expiration, the ATM +2 call should still have at
least $1.00 of premium left in it, and the real risk is more like 0.50 to 0.75. You
will have time to take corrective action. The main danger of this spread is
that the market goes in the direction you predicted but it will move too
slowly and will threaten to stall near your long strike.

page 147

NOTE: If the spread goes in your favor you want to roll it up when your short strike is more
than two strikes in the money. The first step to rolling up a 1 × 2 is to sell your
extra-long call. This turns the original spread into a long put spread with
no risk. If you remember, earlier I talked about this phenomenon where a short
call spread becomes a long put spread when price rolls through the short strike. In
the 1 x 2 you want to lock in your winner, and this will do. The next step is to sell
the new ATM or ATM +1 strike and buy two of the next higher strike
ATM +1 (2) or ATM +2 (2).

page 148

I don’t adjust this trade until either of these occurs:
a) The long side of our trade (2) becomes at least the ATM +1 strike.
b) The market arrives at the long strike on expiration Friday.

In the first scenario, (a), the trade is a winner, and now we want to take advantage
of that. In order to get the full benefit, I will roll it up when the (2) long legs become
the ATM +1. At that point in time, I will be short a call spread and long one extra
call. The short call spread will now act as a long put spread if the market breaks back
toward the original ATM. You may be wondering how a short call spread
turns into a long put spread. It is because the spread reverses as you go
through the strike price of the long option.

When I roll up, I sell one of the long calls
and let the other one act as the long leg of the short spread.

If the market arrives at the long strike (2) on Friday, the short leg will be near
or at parity, and if the market expires on the long strike, the spread will lose the
maximum amount on the trade. 

As a general rule, if you don’t split
strikes you will find that the trade will be near breakeven or a small
loser because of the air left in the long strike (2).

 If you have split strikes,
you have a much bigger problem because the short leg will be at parity and will now
have at least two strikes’ worth of intrinsic value. That is why I don’t do split strikes
1 × 2; it can be very dangerous if you don’t get the move that you need.

page 149

 Bearish Backspread (1 × 2 for Even)

 I initiate
the trade when the shortest time frame that I am observing gives me a
sell signal. Because volatility is generally higher during breaking markets, I don’t
get a chance to use this trade as much as the bullish 1 × 2. In a break from the top
of congestion, the volatility hasn’t generally reached a level that would preclude this
trade; however, in bear markets it will be very tough to execute this trade and I
almost exclusively use the risk reversal or credit spreads.

Buying options outright and the 1 × 2 can be very hard to execute because of
the huge amount of air in the balloon. Again, when you have a lot of air in the
balloon to implement this trade effectively you must ‘‘split the strikes,’’ which
means that they will no longer touch. If you sell the ATM you must buy the ATM
−2 in order to execute this trade for even or a small debit, because the premium
is very evenly distributed (more uncertainty, more premium). If the trade goes
against you, meaning that it breaks slowly, it must break past two strikes in order to
break even.

Rolling Down the Bearish Backspread (1 × 2 for Even)
Rolling this spread down is the mirror image of rolling the bullish backspread up.
You want to roll it down when your short strike is more than two strikes in the
money. The first step to rolling down a 1 × 2 is to sell your extra long put. This
turns the original spread into a long call spread with no risk. The next
step is to sell the new ATM or ATM −1 strike and buy two of the next
lower strike ATM −1 (2) or ATM −2 (2).

Rolling Back the Bearish Backspread (1 × 2 for Even)
Rolling back the 1 × 2 on Friday will depend on where the trade is in relation to the
initial position. If the trade is in my favor (the market is below my longest strike),
I roll back the 1 × 2 by first selling the extra put, creating a credit spread in the
original trade. If it is at a loss (the market is below my short strike but above the long
strike), I cover the initial trade. I then sell the ATM −1 put spread and buy the ATM
−1, −2 (2) put in the next expiring serial. Unless the trade is going badly and my
expiring ATM −1 −2 put spread is in danger of going in the money, I let it expire
worthless. If it is close, you will have to monitor it. My rule is, when in doubt, cover
and go on to the next trade.

page 150

Managing Risk in a Bearish Backspread (1 × 2 for Even)
Managing the risk in the bearish 1 × 2 is the same as it is in the bullish 1 × 2. It has
virtually no downside if the market rallies above our short strike. The biggest risk
is that we are correct in predicting the break, but the rate at which the market is
breaking will place us at our long strike at expiration.
On the winning side, I adjust when:
The short side of my trade (2) becomes at least the ATM −1 strike. I will roll
down by selling the extra-long put and turning the original spread into a long call
spread. This is the exact same trade that I did when I rolled the bullish backspread
up. I then buy the 1 × 2 backspread. If the profit hits on Friday, I close out my
original trade and roll back to the next weekly serial. I will continue to do this roll
until my shortest technical indicator turns bullish.
If the trade is a loser, meaning the market is breaking but it is nearing our long
strike, I know that if I haven’t split strikes there should still be enough premium in
my long strike to mitigate much of my risk. The biggest risk will always be on Friday
if the market arrives at the long strike (2). You will have to make a decision—either
take the loss and roll back to the next serial or manage the trade during the day. I
stay with the trade until about midday; if it is still a problem, then I cover and take
my loss or perhaps a scratch. I will then roll it back to the next weekly serial, and it
will be managed as a new trade; I will let it run until I get a bullish signal.

This chapter married the market theory with trading in congestion. Most of your
trades will be done in the congestion phase of the market, as it represents the biggest
portion of price distribution (+1/−1σ). In addition to recognizing the correct phase
of the market, you must be able to decide the proper trade to use.

As a rule, you can always use credit spreads, as they represent the greatest chance
to turn a profit. You can win even if the price goes slightly against you. They have
limited risk, and also limited reward. Personally, when I am trading credit spreads I
like the 60/40 trade, as I am willing to scratch if price doesn’t go my way, but I like
the bigger punch that they offer.

The risk reversal has greater risk than the outright buy, but the fact that the
premium risk is greatly offset makes this my number one directional trade. It allows
unlimited reward with limited risk and can be initiated no matter how much air is in
the balloon.
The 1 × 2 also has unlimited reward, but if the premium levels don’t allow you to
do touching strikes, the risk of the market slowing down near expiration increases,
and it can cause problems. I like this trade in low-volatility environments, but many
of my students like this trade in any environment. I suggest if you can’t get this trade
in touching strikes that you use one of the three alternatives.

page 155

the double top or double bottom will fail to hold +/−1σ and the trending phase of the market will begin.
Trending markets
are different, and when they begin, the style that is used to trade will also change.
The trades themselves will not change, but when and how to use them will change.

Usually, the first trade in the trend will be a very nice winner. This is because
you should be either long or short from the other side of the market’s double top or
bottom. 

page 156

 I like volatility to be rising, as opposed to declining. Buying a call outright in this type of market is tough, as
the VIX is almost always declining in a low-volatility bullish market. I don’t suggest
buying outright calls with this type of price action. 

page 157

If you are trading multiple shares or contracts, you should lock in profit by
selling part of your inventory. As a rule of thumb, when I am long multiple
positions I recommend selling 50 percent when my shortest time frame
turns negative.

 If you find that it is a problem to
trade in a trending market using two time frames, don’t do it; stay in the
trade until your longest time frame gives the sell signal.

You should still roll this trade up whether or not you are using one of two time
frames. That is the great advantage of trading options; you can always roll up to limit
your intratrade risk without giving back a lot of profit potential. I never roll up
until the new ATM is at least four strikes above my current long call. I
like to roll up to limit my intratrade risk. I am willing to pay the premium to make
sure that in case of a sudden move against me I don’t mimic the underlying asset tick
for tick on the way down. 

page 158

 Generally, bear markets will be characterized by fear,
and that translates into higher volatility. Buying an outright put is similar to buying
a call but has one major difference: The VIX should be rising and not falling.

Buying puts in a rising volatility market is much different than buying calls in a
falling volatility market. In many rapidly declining markets, you can make money
even if you are slightly wrong because the amount of air going in to the balloon can
make the put inflate even if the price of the underlying asset rallies slightly. When
the shortest technical time frame you are observing gives a sell signal,
initiate the trade buying a put.

page 160

Selling credit spreads in a trending market is slightly different from selling in
congestion. You won’t have a double bottom or top to set up your trade. The market
will be in a rotation about its mean but now the mean will have a positive slope. You
still need to get the proper risk/reward ratio, which for an ATM vertical is 2/3.
We are willing to risk $3 for every possible $2 we can make.

If you are more aggressive you could consider the 60/40 spread and see if you
can do it ‘‘Vega neutral.’’ That means that you are collecting a credit equal to or
greater than the debit in terms of air, not nominal price. If the spread expires
here, it will be a scratch trade or very close one way or the other. Unlike the ATM
−1 put spread, we do not make money if the price doesn’t change; the best we
can do is scratch the trade. The 60/40 gives us more upside if we are correct; it is
more aggressive, because we can only make money if we have correctly predicted
the direction of price. The option chain shows that if I sell the ATM +1 put and
buy the ATM −1 put, I am doing the 60/40 delta trade. I can sell the 595 put for
approximately 3.85 and buy the 590 put for approximately 1.44.
Both puts have approximately 1.44 of air and so the trade is right in line. If the
market expires exactly at this price, I will lose 1.44 of air in my long put and the
short put will gain the amount of premium that I lost, so I scratch the trade. The
amount of premium doesn’t have to match to the penny; it needs to be close. If it is
10c or so off against you, still do the trade if your technical analysis is bullish. Our
risk in this trade is slightly bigger, but so is our reward. If we are correct in the
prediction of the price movement, we rate to make as much as 2.40 in this trade,
more than double the straight credit spread.

page 161

Managing the Risk in a Bullish Credit Spread
You should expect to cash a higher percentage of your bullish credit spreads than
you do in congestion. 

Managing the Risk in a Bullish Credit Spread
You should expect to cash a higher percentage of your bullish credit spreads than
you do in congestion. Therefore, I don’t use the iron condor as an initial defense.
In this case, if the bullish credit spread goes against me by more than one strike and
my longest-term indicator is still bullish, I will sell another put spread at the lower
strike. Initiate the trade if the underlying asset price moves to ATM −2.
Sell the ATM −2 −3 put spread. This will double the size of the strike risk
but will also double the size of the profit potential. If you are trading
60/40 spreads, make the same rolldown.
If the underlying market continues to break, you can add spreads as long as your
longest time frame remains in a bullish mode. The original put spreads you sold
will become debit call spreads. I have covered this several times before, and you
should understand this principle by now. If you are confused, please go back to the
section on # the markets. If the market continues to break and your technical
indicators give you a sell signal, you can take a defensive posture by turning your
credit spreads into an iron condor. Initiate the corrective trade by selling the
 +1 call spread X − 1 times. The first bullish put spread should be trading
near parity and has very little risk left in it, so there is no reason to use call spreads
to cover that risk. That is the reason that you sell the call spread one time less than
the bullish put spreads that you used to initiate the trade.

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Managing the Risk in a Bearish Credit Spread
I manage the risk in the bearish credit spread in the same manner as the bullish
vertical. I don’t try to constantly scalp the losers, as I find that unproductive. Instead
I will turn the spread into an iron condor by selling a bullish credit spread.
If I get a reversal signal, I don’t buy back the bearish credit spread I am short. I
sell another credit spread on the other side of the market. So if I am short an ATM
+1 call spread, I then try to ‘‘iron condor’’ it off by selling an ATM −1 put credit
spread. One of the two spreads must go out worthless. If you are lucky, both of
them will. I only buy back my original spread if it is a scratch or a winner. I don’t
want to open myself up to a constant whipsawing by trying to buy them back and
reselling them again.
Which type of bearish credit spread you take is entirely up to you. It
is a function of how much risk you can handle emotionally if things go
wrong. There is no right or wrong trade; it is the degree of risk you can
handle. I am an aggressive trader, so I like the 60/40, even though it has
more risk. I believe that the higher reward is worth it.

Risk Reversal (Synthetic Long)
The risk reversal in a trending market is ideal. You don’t have to worry about
whether volatility is advancing or declining because you are selling almost as much
premium as you are buying. Your risk in this trade will be slightly greater from a
price perspective than an outright call buy, but the virtual elimination of the
premium risk makes me lean toward this trade for aggressive directional
trades. The trade will be initiated when the shortest technical time frame
that you are observing turns positive. In a trending market, I like to use the
ATM −1. You will have no liquidity problems for this trade, as the ATM −1 option
is usually the second most liquid. Since this trade requires three legs, you can do
all three at once, as most platforms will allow you to use a three-legged spread. I
don’t do that, as I believe that you are giving up a big edge to the market makers. I
suggest two ways to initiate this spread. First, buy the call outright and then sell the
put spread. Second, sell the put spread first and then buy the outright call

Rolling Up a Synthetic Long; Locking in Profits
I will roll up if the ATM moves more than two strikes to the upside. I sell a vertical
call spread, replacing my old ATM −2 with a new ATM −2. I don’t have
to replace the put spread because it will offer some protection against a catastrophic
gap opening, but rolling up locks is more profit.

page 164

Managing Risk in a Synthetic Long
Personally, I use my shortest time frame to exit the trade. Most likely, the major
trend will be bullish so I will be neutral the market. I exit by selling my long
call; I let the put spread in place, as it can help me in two ways. First, if the rally
continues and I took profit near the bottom of the short-term break, it will provide
me with extra profit. Second, if the exit was good and the market breaks before I get
my next buy signal, I don’t need to do the three legs again. I simply rebuy the call. If
my major trend turns bearish, I cover the put spread and either reduce my profit in
the overall trade or increase it slightly if the break is very minor.

Rolling Down a Synthetic Short; Taking Short-Term Profits
As long as all of my technical indicators remain bearish, I will roll down my synthetic
short if the ATM moves more than two strikes to the downside. I sell a vertical
put spread, replacing my old ATM +2 with a new ATM +2. You can sell the
ATM +2 +4 call spread to remove all premium risk, or you can let the old spread
remain intact. You don’t have to roll down if you are willing to take the intratrade
risk, and I know many successful traders who never roll down.
Rolling Back a Synthetic Short
Rolling back a synthetic short is the same operation as rolling back a synthetic long.
Friday, I roll back the risk reversal by first selling the horizontal put spread. In this
trade, you must sell your long put and buy the next weekly serial ATM +2 put.
After the roll is in place, I sell the next week ATM −2 −4 put spread. Unless the
trade is going badly and my expiring ATM −2 −4 put spread is in danger of going in
the money, I let it expire worthless. If it is close, you will have to monitor it. If you
are unable to monitor it during the day, it is best to cover and go to the next trade.
Managing Risk in a Synthetic Short
When I get a buy signal in my shortest time frame, I exit by selling my long put.
This trade is the mirror of the long risk reversal. I let the call spread in place to help
me. If I have taken profit near a short-term top or the market remains close to my
buy, it can be used to finance my reentry with a new put if I get a new short-term
sell signal.
The biggest edge using risk reversals becomes obvious when you consider margin.
Instead of paying a Reg T amount of 50 percent, you end up buying the stock for
about 3 to 5 percent of the face value, with all of the profit potential and none of the
major risk of owning shares.

The Bullish Backspread (1 × 2 for Even)
This trade works very well in a trending market. I prefer to use it in a downtrend,
as the price action is generally better. Generally in a breaking market volatility
is rising, and since you are long two options for every one that you are short,
you benefit greatly if air is coming into the balloon. On the other hand, if the
165
TRADINGINATRENDINGPHASEOFTHEMARKET
166
T
EKRAMEHTFOESAHPGNIDNERTANIGNIDARTmarket suddenly reverses and goes higher, your risk is limited to the debit you
paid. If volatility is already very high—say in the upper 20 percent of
historical volatility—I don’t recommend using this trade. You will have
to split strikes, and that can take away much of the edge that you get by using the
backspread. When the shortest time frame you are observing gives a buy
signal, initiate the trade by selling the ATM or ATM +1 strike and buy
two of the next higher strike ATM +1 (2) or ATM +2 (2).
Rolling Up the Bullish Backspread (1 × 2 for Even); Taking Profit
If the spread goes in your favor, you want to roll it up when your short strike is more
than two strikes in the money. The first step to rolling up a 1 × 2 is to sell your extra
long call. This turns the original spread into a long put spread with no
risk. The next step is to sell the new ATM or ATM +1 strike and buy two
of the next higher strike ATM +1 (2) or ATM +2 (2). You don’t have to roll
up if you don’t want to, but it is recommended to manage your intraday risk.
Rolling Back the Bullish Backspread (1 × 2 for Even)
Rolling back the 1 × 2 on Friday will depend where the trade is in relation to where
you initiated it. If the trade is in your favor (the market is above your long strike),
I roll back the 1 × 2 by first selling the extra call, creating a credit spread in the
original trade. If you don’t have the ability to monitor the residual call spread, close
the entire trade. If it is at a loss (the market is below your long strike but above the
short strike), I cover the initial trade. Next you must go to the next week ATM +1
+2 call and initiate the new trade.
Managing Risk in a Bullish Backspread (1 × 2 for Even)
Managing the risk in the bullish 1 × 2 is different in a trending market. It has the
same downside in that, if the market reverses, its risk is limited to the initial debit
or credit. However, if the trade is going your way and you get a short-term sell
signal, it is important that you take the entire spread off. What you will find is the
unpleasant side effect of the trade ‘‘racing’’ to the downside. If you didn’t roll
up, you will be naked a near parity call and also short a near parity
put spread. Your long call spread will have rolled over into a short put
spread. Some inexperienced traders learn this lesson the hard way, and it is an
eye-opener. Backspreads are fantastic when the market is in a big trend, but if it
suddenly turns choppy, you will need to cover quickly.
The Bearish Backspread (1 × 2 for Even)
The bearish backspread in a selloff is usually very favorable because volatility is
inevitably on the rise. Theoretically, the trade doesn’t have unlimited reward
because the asset can only go to zero, but for all practical purposes, it is the exact
same trade. Initiate the trade when the shortest time frame that you are
observing gives a sell signal. If the volatility is in the upper 20 percent
of the historical average, don’t use this trade. Because volatility is generally
higher during breaking markets, I don’t get a chance to use this trade as much as the
bullish 1 × 2. To implement this trade effectively, you must ‘‘split the strikes,’’
which means that they will no longer touch when you have a lot of air in the balloon.
If you sell the ATM, you must buy the ATM −2 in order to execute this trade
for even or a small debit, because the premium is very evenly distributed (more
uncertainty, more premium). If the trade goes against you, meaning that its price
retreats slowly, it must break past two strikes in order to break even.
The main danger of the bearish 1 × 2 spread is that the market breaks but it
will move too slowly and will threaten to stall near your long strike. If the market
remains above the ATM −1 strike, all of the options would go out worthless and
you have very little risk. To initiate this trade, sell the ATM or ATM −1 strike and
buy two of the next lower strike ATM −1 (2) or ATM −2 (2).
Rolling Down the Bearish Backspread (1 × 2 for Even); Taking
Profit
Rolling this spread down is the mirror image of rolling the bullish backspread up.
You want to roll it down when your short strike is more than two strikes in the
money. The first step to rolling down a 1 × 2 is to sell your extra long put. This
turns the original spread into a long call spread with no risk. The next
step is to sell the new ATM or ATM −1 strike and buy two of the next
lower strike ATM −1 (2) or ATM −2 (2).
Managing Risk in a Bearish Backspread (1 × 2 for Even)
Managing the risk in the bearish 1 × 2 is different in a trending market. It has the
same downside in that, if the market reverses, its risk is limited to the initial debit
or credit. However, exactly like the call spread, if the trade is going your way and
you get a short-term buy signal, you should close the entire spread. It is better to
take this trade off too early than to let it ‘‘blow back’’ in your face. Sometimes you
will take the trade off at the top tick, and that is part of trading, but in the long run,
a big reversal in this trade is very disheartening. If the major trend continues lower,
when your short-term signal gets short again, initiate the spread again.

page 173

rade the final is initiated, stage of almost the market, all the the information blowoff, about and it the
 is current market is in place. Initially we broke out above or below the congestion
at +/− 1σ and moved through the trend at +/− 2,3σ; the market has arrived at
+/− 3σ and only a small amount of data is not contained under the distribution
curve. One of the reasons that I like volatile stocks is that they have blowoffs more
frequently.

When the market is at extremes, many traders heed the old expression that it is
impossible to catch a falling knife. You will learn that not only is it possible—it is
one of the best trades that you can make! Some professional traders do nothing but
scan the markets to find this type of trade. The key is to know how to initiate it and
how to manage it.

page 176

Buying a call outright in a blowoff is extremely difficult. The premium levels are
simply too high. Remember from earlier in the book you learned that the premium
levels in each strike are the same. The market makers put them in line through
conversions and reversals. It is a riskless trade for them and it keeps the premium
equally distributed among the strikes in the option chain. So if a market is blowing
off to the bottom, you can be confident that the shorts will be covering at any price.
As they buy back their short puts, it inflates the balloon in proportion to the price
they are paying to cover, and consequently that premium will overflow into the calls.
Even with a few days to go in a blowoff, the premium levels will be dangerously
high, and it will be very tough to make money. For this reason, buying a call is not
the correct play. Never buy calls in a blowoff; there are many other trades
that are superior.

 Never buy puts in a blowoff; there is a huge downside to this trade
and very little upside.

page 177

Sell a Bullish 60/40 Credit Spread
Selling credit spreads in a blowoff is different than trading in congestion or trending
markets. The reason is that the premium levels rate is extremely high, the air in the
balloon is going to make the ATM and ATM +/−1 nearly the same. This is logical
as well as mathematically correct. The market will still gyrate around its mean, but
with so much uncertainty, the strikes near the ATM will all have similar amounts
of premium. Consequently, it will be hard to get the correct 2/3 risk ratio that we
looked for in our other trades. If you want to make the ATM your short strike, you
will probably need to go to the ATM −2 or −3 for your long strike. This creates
more risk and not much extra reward because the market will be flying around at the
blowoff bottom. For that reason, you shouldn’t initiate this trade. In this
environment, the 60/40 bullish credit spread is a much better choice.
The strikes will most likely be the ATM +2 /−2, but this increased spread gives
you real punch for your money. The blowoff is the most directional trade that you
will make, and you want a trade that will give you the best chance to catch a big
winner. The 60/40 trade is initiated when the shortest time frame you are
observing gives a bullish technical indicator.
The key to all blowoff trades is to allow the market to tell you that it is ready to
stop breaking or rallying. The way that is done is to let your shortest time frame roll
over and then make the trade. You are not trying to catch the knife; you are trying
to get onboard for what figures to be a nice rally or break.
Rolling Up a Bullish 60/40 Credit Spread; Taking Short-Term
Profit
If the market rallies after you initiate the bullish credit spread, you must still manage
your winner. The price action in this environment should be very quick. Many times
it will cover as much ground up and down in a day as the congestion phase of the
market did in a week. Rolling up is much more important in a blowoff market.
Unlike before, where it was a suggestion, here it is a rule. You don’t want to give
up big profits if the market suddenly reverses and heads back to the bottom or top.

When the market advances to at least ATM +4 from my short leg of the
credit spread, sell the new ATM 60/40 put spread. If the longest time frame
that you are trading is now giving a reversal signal, you can let the old spread stay
on the books, as you are now a very big favorite to cash that trade also. If you are
conservative and are concerned about a sudden reversal of fortunes, you can buy
back the original spread.

page 178

Managing the Risk in a Bullish 60/40 Credit Spread
Managing the risk in a 60/40 spread in a blowoff depends on how aggressive you
are. It will be harder to turn this spread into an iron condor because the strikes
are spread wider due to the increased premium levels. If the spread is a loser when
the shortest time frame turns negative, you can’t average down if the longest time
frame hasn’t turned to bullish. If the longest time frame is still bearish, I will take my
loser and look for a new entry position if the shortest time frame again goes bullish.
If I get a reversal in my shortest time frame and my longest time frame has turned
positive, I will average down by selling another 60/40 spread at the better price.
Initiate the trade if the underlying asset price moves to ATM −2. Sell
the ATM +2/−2 60/40 put spread. This will double the size of the strike
risk but will also double the size of the profit potential. If the underlying
market continues to break, you can add spreads as long as your longest time frame
remains in a bullish mode. The original 60/40 put spreads you sold will become
debit call spreads. If the longest-term technical indicator reverses and gives you a
bearish signal, cover the spreads and take a loss, looking for a new entry point if the
shortest signal turns bullish.

[NOTE practicing the 60/40 during normal cycles will preapare for using it in blowoffs]

Sell a Bearish Credit 60/40 Spread
The bearish credit spread will take place if the market is in a blowoff to the upside.
The conditions will be slightly different than a downside blowoff. In this case, the
strong hands are the bulls and the shorts are throwing in the towel. You should expect
high volatilities but, generally speaking, they will not be as high as a breaking market.
Most likely, it will still be very difficult to get the proper 2/3 risk/reward ratio, so
go directly to your 60/40 spread. In this case, we are not trying to catch the falling
knife; we are watching a rocket ship reach its zenith and waiting for gravity to take
over. The 60/40 bearish credit trade is initiated when the shortest time
frame you are observing gives a short technical indicator. Sell the ATM
−2/+2 call spread.

page 179

Rolling Down a Bearish 60/40 Credit Spread; Taking Short-Term
Profit
The price action in the upside blowoff phase should be very quick. Rolling down in
this spread is a rule. You don’t want to give up big profits if the market suddenly
reverses and heads back up to new highs. When the market breaks to at least
ATM −4 from my long leg of the credit spread, sell the new ATM 60/40
call spread. If the longest time frame that you are trading is now giving a bearish
signal, you can let the old spread stay on the books, as you are now a very big favorite
to cash that trade also. If you are conservative and are concerned about a sudden
reversal of fortunes, you can buy back the original spread.

Rolling Back a 60/40 Bearish Credit Spread
On Friday, I roll back the bearish 60/40 spread in the next weekly. I only buy back
my existing spread if it is in danger of going out as a loser. If it is beyond the expected
range, I will leave it in place. Even if the market starts to move against me that late
in the week, I can always take the expiring spread off. Many times, it will be so far
out of the money that even adverse price movement will not affect the trade.

Managing the Risk in a Bearish 60/40 Credit Spread
Managing the risk in a bearish 60/40 spread in a blowoff is the mirror image of
managing the bullish 60/40. You will probably have the same problem with split
strikes because of the higher levels of volatility. If the spread is a loser when the
shortest time frame turns positive, you can’t average up as you would in a trending
market, because the longest time frame will not have turned negative. In this case,
I will take my loser and look for a new entry position if the shortest time frame
again goes bearish. If I get a reversal in my shortest time frame and my longest time
frame has turned positive, I will average up by selling another 60/40 spread at the
better price. Initiate the trade if the underlying asset price moves to ATM
+2. Sell the ATM −2 /+2 60/40 call spread. This will double the size of
the strike risk but will also double the size of the profit potential. If the
underlying market continues to rally, you can add spreads as long as your longest
time frame remains in a bearish frame. The original 60/40 call spreads you sold will
become debit put spreads. If the longest-term technical indicator reverses and gives
you a bullish signal, cover the spreads and take your loss, looking for a new entry
point if my shortest signal turns negative.
In a blowoff market environment, don’t trade the traditional ATM +/−1. Look
directly to the 60/40 spread.

page 180 

Risk Reversal (Synthetic Long)
The risk reversal in a blowoff market is a bread-and-butter trade. It is almost
impossible to make a directional trade buying outright options when the volatility
levels get to extremes, so using a risk reversal is the ideal trade. You have very little
premium risk in the trade and you get the full punch from the price movement if
you are correct. If you are wrong and the market gaps against your position, the risk
is still limited to the strike risk in the corresponding call/put spread. The trade
will be initiated when the shortest technical time frame that you are
observing turns positive. The only variation in this trade will be that you must
increase the strike risk in the short put spread to accommodate the extremes of
premium. If you are using the ATM−1,−2 call/put, you probably will need to buy
the ATM −5, −6 put to complete the trade. This does increase your downside risk
but it is worth it to keep any premium to a minimum in case the market suddenly
stalls and the short sellers take the air out of the balloon.
Rolling Up a Synthetic Long; Locking in Profits
I will roll up if the ATM moves more than two strikes to the upside. I sell a vertical
call spread, replacing my old ATM −1,−2 with a new ATM −1,−2. I
don’t have to replace the put spread because it will offer some protection against
a catastrophic gap opening, but rolling up locks in more profit. I believe that not
rolling up when the ATM goes two strikes in your favor is a mistake. I don’t make it
a rule, as it is in the 60/40 credit spread, but I believe in cutting intratrade risk as
much as possible.

Rolling Back a Synthetic Long
On Friday, I roll back the risk reversal by first selling the horizontal call spread. In
this trade you must sell your long call and buy the next weekly serial ATM −1−2
call. After the roll is in place I sell the ATM−5 −6 put spread. Unless the trade is
going badly and my expiring ATM−5 −6 put spread is in danger of going in the
money, I let it expire worthless.
Managing Risk in a Synthetic Long
This trade is managed similar to the trending market trade. If I get a sell signal in my
shortest time frame that I am trading and the longest trend is still negative, I exit the
trade by selling the call and buying back my put spread. If the long-term trend has
changed, I exit my call and leave the put spread in place. Most likely I am locking in
profit. If the short-term signal becomes bullish again, I replace the original call with
the ATM −1,−2 and recycle the trade. If the major trend turns bearish before I get
a signal to reenter, I buy back my put spread and look for a new entry point.


page 181

Risk Reversal (Synthetic Short)
The risk reversal at the blowoff top will be treated very similar to the blowoff
bottom. Since we are initiating it from the short side of the market, the OTM calls
should not be blown up as much as the puts in the blowoff low. The premium risk
will be somewhat mitigated, and you can probably sell the ATM +2, 4, or 5 call
spread. The trade will be initiated when the shortest technical time frame
that you are observing turns negative. If you are using the ATM +1,+ 2
put/call, you probably will need to buy the ATM +2,+4 call to complete the trade.
The upside risk is cut down considerably if are able to buy a call closer to your short.
Rolling Down a Synthetic Short; Locking in Profits
I will roll down if the ATM moves more than two strikes to the downside. I sell
a vertical put spread, replacing my old ATM +1,+2 with a new ATM
+1,+2. I don’t have to replace the call spread because it will offer some protection
against a catastrophic gap opening, but rolling down locks in more profit. I believe
that not rolling down when the ATM goes two strikes in your favor is a mistake.
I don’t make it a rule, as it is in the 60/40 credit spread, but I believe in cutting
intratrade risk as much as possible.
Rolling Back a Synthetic Short
On Friday, I roll back the risk reversal by first selling the horizontal put spread. In
this trade, you must sell your long put and then buy the next weekly serial ATM
+1+2 put. After the roll is in place, I sell the ATM +1,+2 +4 −5 call spread.
Unless the trade is going badly and my expiring ATM +1, +2 +4 −5 call spread is
in danger of going in the money, I let it expire worthless.
Managing Risk in a Synthetic Short
This trade is managed similar to a bearish trade in a trending market. If I get a buy
signal in the shortest time frame that I am trading and the longest trend is still bullish
I exit the trade by selling the put and buying back my call spread. If the long-term
trend has changed I exit my put and leave the call spread in place. If the short term
signal becomes bearish again I replace the original put with the ATM +1,+2 and
recycle the trade. If the major trend turns bullish before I get a signal to reenter, I
buy back my call spread and look for a new entry point.

Risk reversals are the only way to go when you want to get short a runaway
market and want an unlimited reward, limited risk trade. No FINRA problems, no
Reg T problems, and you will get the full benefit if you are correct as to the next
move in price. If you are wrong, your risk is limited.

page 182

The backspread works very well in many market and premium environments, but
at blowoff levels you can get quite a bit of heartburn using it. You have a number
of issues to deal with in the blowoff environment that weren’t a problem when the
market was in congestion and when it is trending.
You are buying two options and selling one, so you are long Vegas. Being long
premium when the balloon is full of air is not a good idea. Earlier in the chapter,
you observed what can happen if you buy premium in a contracting phase of the
option market; you get hammered. Even if the market moves substantially when
the fear or greed starts to be accounted for, sellers that had the capital to survive
the combination of negative price movement and the escalating premium will be
waiting, and they will be selling it with both hands. In addition, the traders that were
long air during the explosion are going to want to take profit, and they also know
that the current premium levels probably will not support the underlying asset’s
price movement. They will join their former adversaries and become sellers in the
new market.
The second problem is an extension of the first one. In order to do the trade
anywhere near Vega neutral, you are going to need to split your strikes quite a
bit, and this can create an ugly problem near expiration. Unlike the low premium
environments where the tight strikes prices offset almost all of the expiration risk
in a high-Vega environment, they do the opposite; they create a huge risk. As an
example, if you had to split your strikes by 3 or 4 to get a proper Vega fit, and the
market decides to pin on expiration at your long strike, there is no defense for this
type of price movement. Your short strike will now be near parity, and even though
your long strike will contain two options with some air in them, the trade will blow
up on you.
The third problem will be if the market remains close to your short strike on
expiration. It will be the ATM and the trend will rotate around that mean, most
likely +/−1σ. Your two long options will be too far away from your short to help,
and you will be tortured by the short strike until the last few minutes. Of course,
if you are dead right about price, then the trade works very well, but if you are
correct in predicting the price movement, the risk reversal works much better. You
are buying two options in that trade and selling one, so you are long an extra option.
However, much of the Vega risk is alleviated because you buy and sell the same
amount of Vega in your two ATM +1/−1 options. You will own much less Vega in
the out-of-the-money put/call and so a complete collapse of premium will not hurt
you nearly as much. On the other hand, if you are wrong about price, you don’t
have any pin risk, only the market risk, as in all trades.
In a blowoff market, don’t use 1 × 2 backspreads unless you can get touching
strikes. Employ either credit spreads or risk reversals.

page 189

When establishing a portfolio the three factors concerning liquidity
are: the bid–offer spread, the expected range of the stock, and the size
of the underlying security.

page 190

When we price a portfolio, in addition to liquidity you need to factor in volatility.
If you are choosing between two stocks with similar dollar prices, the more
volatile stock is the one you want in your portfolio.

When you have at least five stocks from different
groups in place, you are ready to begin trading.

e. If you are
trading at the maximum portfolio size of $100,000+ you should be observing at
least 50 stocks that fit the criteria of liquidity and volatility at all times. Even if
you are trading at the minimum size of $1,000, you need at least 10 stocks in your
observation list

page 192

Dollar balance the portfolio by trading based upon EV ratios.  (Expiry Volatility) I believe.

page 199

If you trade with a method
that has a higher percentage of wins, you will be able to withstand losing streaks
much better. In general, go with the method that gives you the highest percentage
of winning trades.

page 200

As a rule, you should never risk more than 3 to 4
percent of your capital in any trade

 Theoretically,
you could have as many as 30 different trades in action and still be within the risk
parameters described in this chapter. Managing that many trades would be extremely
difficult and it is not recommended, but if you can manage that many, it would be
workable. In practice, if you are trading in the shorter time frames (swing trades),
5 to 10 simultaneous trades would probably be the most that you could manage.

page 203

Always concentrate on the stocks with the highest EV; those stocks will be the
most liquid, and the more liquidity, the better the chance that you will be able
to overcome the bid–offer spread and commissions. Remember, you don’t get a
commission discount because the price of the stock is lower. As the EV declines,
it means that the commission dollars that you are spending increase in relation to
the potential profit, even if you are trading a position that has limited risk and
unlimited reward.