Questions and Answers

I received these question from a fellow Tradeologist and thought it would be helpful to pass the questions and my answers along to everyone. I hope it helps you to understand why the VIX is so important and why I have not recommended monthly income trades during this crazy market.  I will draw your attention to the second part of his questions and my reply on why we use the VIX and it’s importance in determining market direction. -Dave

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Part 1:

QUES:

“Dave,

I just finished your course (viewed it twice). I’m a little confused about the SPY,DIA, EWM (S&P, Dow, and Russell).  How is it diversifying the risk, if all these ETF’s move in concert with each other?  Or is the practice to diversity the risk by “putting them on” at different times?

Also, It seems that the trade takes 30-45 days to develop. It seems them that we don’t know if it’s a losing position until …Day 25 or so into it. Also, if we stagger the entry, how does that work if the exits are almost always “just prior to expiration”?”

You course is very good.  After taking other courses/seminars, I’ve learned never to listen to anyone unless they trade there own cash and make a living doing it.  How long have you been trading for a living?” [Name withheld]

ANS:

“Hi [name],

Thanks for the note…

The idea of ‘diversification’ is to place credit spreads on at times in which the market is at extremes and then at different times.

The only real ‘sure thing’ in the market is that all options decay in value if they are out of the money… the more ‘theta’ we can collect the better – it’s our ‘inventory’ in this business. We sell high (theta) then buy back at lower prices (commission-free if they are .05 cents or less on TOS).

I’ve been trading for about 20 years but got serious 3 years ago and started learning how to make my living in the markets. I have a couple of mentors that used to trade on the CBOE and one guy in Arizona who has been doing this for 20+ years on his own.”

Part 2:

QUES:

“Dave,

I think I understand the concept. The practice account will help drill it in.  The adjustments….that’s another chapter.  Another question, for markets that are moving in a range, but will go up or down, don’t we still need to understand the direction (or predict price) somewhat, to get the channel direction right?  Also it seems I need to predict the direction within a range for at least …30-45 days.  Yes, I know…we try not to predict price. But I’m having a hard time predicting it for next week, let alone the next 30-45 days. -Name Withheld”

ANS:

“Hi,

Yes, you do need some idea of direction. In the past it was not as important… markets were relatively calm and stayed within predictable ranges based on the low volatility – I mean 25 was HIGH VOL!… It hit 80 not too long ago and changed the game….

That’s why in the Daily Reviews I have been spending more and more time on technical analysis and market direction. Once volatility drops under 40 things get a bit more predictable.

Volatility has changed the markets. If the VOL was 20, well you can divide that by 20 days (the average number of trading days in a month) and get the expected price range (from high to low) in percentage terms daily of about 1% per day. [CLARIFICATION: When the DOW was at 10,000 and the VIX was at 20 you could say with some confidence that the DOW would move within a 100 point range the next day. When the DOW hit 9500 and the VIX jumped to 60 then you could predict that the DOW's range on a daily basis was going to be around 300 points per day! When we hit 8500 and the DOW jumped to 80 we could predict ranges of 400 points per day or more - in fact many times we had ranges of up to 500-1000 points per day!]

So for example, right now the Volatility (I use the VIX) is at 43.38. Divide that by 20 and you get 2.16. That’s the kind of percentage move you COULD get in a day. 2.16% of the DOW at 8515 is 184 points. That represents a 184 point swing from high to low. As the VIX drops we will get smaller range days – and we’ve seen that over the last few weeks as the VIX has dropped from 80 down to 43.

So using Iron Condors when the VOL is high gives you an idea why it’s so dangerous – at 75-80 VIX the range in a day could easily be 500-1000 points! And that’s exactly what we had in October and November on some days.

Anyway… predicting price ranges helps to some degree- if you know the VIX is trending lower then you know the market will trade in narrow ranges and trend up (higher) over the near future.

If the VIX is trending higher then the market will trend lower and with larger range days…

Understanding which way the VIX is likely to go will help determine which strategy you want to use within the 30-45 day time period you’re trading.

I hope that helps,

-Dave”