New Video – Trading Options With an Edge
With Jeff Tomasulo and Joel Johnson.
In 2001, after the market crashed, I was introduced to options. And the one thing that I loved about options right off the bat was I had this guy explained to me that, Hey, if AAPL, Joel type of apple, so we can do a today example, right? And this is what blew me away. And still to this day blows me away.
He said, Jeff, he goes, if I could show you a way that you're going to make. $200 and all you're going to risk is $600 and you have an 80% chance that they're going to make a $200. And the next 30 days, as long as Apple stays below150. And what is Apple trading that today? Guys? I think it's trading at a hundred fifty.
And where is it? So if all in the next 30 days, you're going to make that $200. You have an 80% chance, right. To make the $200, as long as Apple stays below $150. And the most you'lll ever lose on this trade is 600 bucks.
And I was like, well, how do you know that?
Right. Because right when I just said that, how do you know that? And that was the biggest problem that I had as a trader. Remember guys, I made millions of dollars directional trading. Right from 1996 to 2001, but I never had that confidence.
We used momentum trading, but as soon as it, it dried up, a lot of that didn't work. So I was always a, and, and even when I put the trades on back, then a lot of it only worked 50% of the time, so, or less. And it was very frustration frustrated to me because there was no consistent. And when I was finally taught that, Hey, there is math out there, probability and statistics that you can use that is going to give you an 80% chance that you're going to make 200 bucks.
And the most you can lose is $600, because remember a lot of the fear that a lot of their new investors, especially. Right. They have this fear of, Hey, I don't know how much I'm going to lose on this trade. Right? And a lot of times they're trading way too big, but the fact that you can define your risk and that you have a percentage that you know, that 80%, you have an 80% probability that apple is going to stay under $160.
Right there kind of changed the way I looked at the world of investing because for the first time in my career, I finally found that felt, felt like I had an edge. Where before? Yes. I know, you know, we, we use these techniques and we use sector, you know, we use moving averages and we, you know, one moving average crosses another.
We, you know, we try to use candlesticks, but when you really break it down and you try to get probabilities on how well they work in certain markets, environments, they work really well. And other markets, environments, they work really crappy, right. Where you have in the option market. You have this thing called and don't worry about this.
This is not to scare you guys because remember I have a sh I have a T I'm terrible at math, and if it wasn't for computers, I wouldn't be able to do what I do today. But the fact that there's a mathematical formula out there that is telling you in the markets and it's actually evaluating the option market and the, and the stock market in how a stock is moving every single minute of the day and telling you the probabilities of half, you know, how, you know, if a stock's going to go over a certain price or under a certain price to me that opened my eyes to consistency.
And once I started to apply some of these strategies inside my overall portfolio, I became so damn consistent. Right? So that was one of the reasons why all of a sudden from 2002 to the present, most of my trade ins started to be used in auctions. And then the other thing, the other reason why, uh, I love options and I continue to use options is because pick and direction.
It's extremely hard. Right. And I know Pete works with you guys to help you do that, but it's not an easy ballgame. It's not a, a ball game where you can be as consistent or for years be consistent. You'll have good streaks, but you need another strategy with inside that portfolio to help you compliment when that strategy is not working.
Right. So when that directional strategy is not. And then the other beautiful part is that when you have a small account to be able to use the power of leverage is so significant in helping you grow a small account much quicker than you would, if you would just try to trade stocks. Because as Joel alluded to, and I'm sure Pete has talked to you guys about this numerous times when you're trading these really expensive stocks, or you try to trade these really expensive stocks, they take up a huge amount of your, uh, your cash in your account.
So it limits you to the possibility where you're stuck in one or two or three stocks. We are, if you're able to understand leverage and the inherent leverage that option half options have and futures have it is so crazy. I tell you guys, I cannot stress how quick you can grow your account, if you know how to use your leverage smartly.
Right? So when you think about that is that I can be wrong about direction and still make money using options. I have a, I have a mathematical edge in the market while I use an option. And I also, if I have a small account options, benefit me more than anything else to help me grow that account. Right. I mean, that to me is absolutely huge.
And then I also get a diversification. Because what we talk about all the time in my hedge fund is being non-correlated and non-correlated, we can get into much later, but having another strategy, another tool within inside your portfolio to make money because options can be used on stuff. Options can be used on futures.
Options can be used on currencies. Options can be used on ETFs. I mean, they can be used on, in so many different ways. It gives you the ability to have another tool to help you make money on top of the strategies that you're using. So would you like to add to anything? And I would love to add to this, Jeff, and if you don't mind sharing what I'd love to do is can we talk about the trade?
You guys closed out this morning, the Coinbase trade. Absolutely. So, so, um, how, first of all, before we go into this, how many of you guys just type it in the chat? How many of you guys are brand new to options and have never placed an option trade before? Uh, and how many of you guys are experienced option traders or, or have at least done some option trading.
Okay. So before we go on, yeah, we've got a lot of brand new. Uh, let's see, we got, got a few in here. The leaps has seven years of options. Awesome. Delete a long spreads. All of the above
got Rauf. Who's got a few too as well. Kate, we've got a few people. Who've got five years, but, uh, came most people are, Scott says I'm experienced at losing with them and that's experienced. Okay guys, that's one of the things that we would love to do, at least I would love to do for you guys to walk away today with the excitement that there is no reason why you should be losing in, in trading options.
I mean, everybody does lose, but the fact, if you get some simple, I, you know, simple little techniques to find out when you should be buying options, when you should be selling out. Once you get this little thing down, it kind of opens your eyes to saying, Hey, I've been doing this wrong because that's what Joel and I did.
I mean, when I first started out, I started out like you guys, I was trying to buy options directionally, and then over trial and error and losing tons of money. I was like, shit, that this doesn't work. And then I, I ended up putting two and two together and started to test all different types of strategies.
And we're going to get through that. Yeah, it's not that the option trading doesn't work it's that whatever approach you are using doesn't work. Right. I'm like great. I love that. Joel, Mike says 10 to 12 trades per month. Mostly options, all sorts of different strategies. That's awesome. Florence sells spreads.
Okay. So before going into this trade, I want to explain just a little bit about this. Um, Uh, because options can be really intimidating and confusing when you're first learning that I know that because I had to learn them at some point, Jeff has been through that. Pete plays humble, but Pete knows what he's talking about.
Right. Um, when it comes to trading options, one of the first thing you have to understand is what Jeff was talking about. You have to get that specific education. So options are contracts. That's all, they are their contracts. They give you, uh, rights around stock. So if you buy a call option, what you're doing is you're spending money to enter into a contract.
And this contract has leveraged and that's why people like options. So I'm just going to go through a quick demonstration here, real quick guys, of, of why people like options. Now I'm going to stick with Coinbase. Uh, if you haven't heard of Coinbase, Coinbase is really the market leader for cryptocurrency trading.
Uh, they're, they're kind of a, uh, they're a hybrid crypto exchange slash broker, I guess, is the best way to extreme. Explain what Coinbase is. They just barely went public, uh, in, in April. So there, you can see this chart, doesn't go back very far. Uh, but it's very, very exciting stuff. Part of the problem here is it's not the cheapest stock in the world.
Um, and somebody like let's say, Deepak just typed in Deepak just said, Hey, I've only got 900 bucks to spend on my investing. Well, this is where I talked about earlier options of the great leveling field. So first of all, if I wanted to buy a hundred shares of stock in this. That's going to cost almost 25 grand, right?
By the time you buy a hundred shares, you want one, just one round, lot of stock. That's what you're looking at. Now. The reality is, is most retail traders don't have that much money to put into a single person. Right. Maybe you've got, maybe you're doing pretty well for yourself. Maybe you even got a couple of hundred thousand dollars in your account.
Are you really willing to put 25 grand of that into one single stock? That's a lot of your account to put into one single trade and that's kind of the problem with stocks. Right? And, and if you're some Deepak, I hope you don't mind. So you typed it in, I'm assuming it's fair to mention it. Um, yeah, you can't trade this with 900 bucks.
You can buy three shares and then. You're out. That's your entire account, right? If this stock doesn't do anything, you're just sitting on your thumbs. If it crashes, there goes your account. Now, a lot of people just say, well, I could just go buy it option right now. One of the beauties of it options is how much cheaper they are than the stock.
That's one of the things that attracts most of us to trading options. When we first get started, I'd be willing to bet. If we were in a live room right now, if, if we were meeting face to face, uh, that if I said, how many of you guys are attracted to options? Because they're cheaper, I'm going to guess 99% of the room would raise their hand.
The other 1% wouldn't because they're the people who don't want to raise their hand, or they didn't hear that. Right. The fact that they're cheaper provides that leverage, which is what Jeff was talking about, that we're looking for. So I'm just going to do like an example, like a hypothetical, I'm just going to buy an option.
Now there's rules about which option you should buy in which circumstances I'm not going to go into that right now. Go ahead, Jeff, because that's a Christian and that I saw come through, you know, Thomas R U S said the Greeks and what options to buy as a hard for me to understand, and that. One of the key mistakes that everybody in and trading options who don't have experienced does all the time.
They buy options when they should be selling options and they sell options when they should be buying options, or they're afraid to sell options when you know, and understanding that I will change the way you look at options, uh, forever. But Joel is going to give we'll get into that a little. Yeah. So again, I'm not going to go into the math behind these rules guy, guys right now, but there it is men.
And that's one of my favorite things about options is that they're men. We're not going to dive super deep in the math today just because of time constraints. But let me kind of give you the reader's digest version of the math. Um, the natural inclination for people buying options is they're going to want to buy the option that's at the money or what we call just out of the money.
So the stock right now is trading for $245. People are going to come in and they're going to buy the 245 strike price call. Now the strike price also known as the contract price is the price that you agreed to trade the stock for in the future. So if you buy a 245 strike call, what you're actually buying is the right to purchase 100 shares of stock for $245 a piece.
At any time between now and expiration when the option expires options, have an expiration date in this case 32 days from today on this option that I'm looking at. So if we were to buy this option, it gives us the right to buy the stock for $245. Now, the reason we would do this is first of all, it's cheaper than buying the stock.
That's got an asking price of 1960. Which is an option represents 100 shares. So that's $1,960 per share. Now this is where a lot of beginning, often traders go now, hang on with me. If you're one of those people who says, but Joel, I've only got a thousand bucks or that we're getting to that we've got an option.
It's gonna cost us two grand. Now that's a whole lot less than 25 grand to buy the stock, but it's the wrong option to buy naturally retail traders want to do this? Um, who was it you just typed in here? RG just typed and said, I always seem to lose when I buy because of time or direction or sell. Okay. So RG, we've got to work on both those.
So the problem is buying an option. You, you, you have to be right about the direction of the stock and you have to be right about when it does it. You've got time working against you. Anytime you buy an option. Now, again, without going too deep into the math. And this has to do a lot with what are called the option.
Greeks. If all you're doing is just buying an option under normal circumstances, under normal circumstances. We're going to go with one that's deeper in the money. Now, a lot of beginning option traders will say, but Joel, that's more than twice as much money. That's four grand. Why would I do that? I can buy two of those cheaper options for the price of the one expensive one.
My answer is you get what you pay. The deep in the money option is going to have a significantly higher probability of making you any money at all, a higher probability of at least breaking even a higher probability of success and will be an easier trade to manage in every single way. So right away, those of you who are going the reason for this is it shielding you a bit from the impact.
Time, decay and volatility. Richard says, Hey, this option chain looks upside down from the one I'm used to on think or swim. You know what, Richard, just for you, I will reverse that.
There you go. Something you're more comfortable seeing that way. Richard,
you get on our platform, you can arrange that either. Right. Um, and this is, this is our proprietary platform. The tactical. Platform. Scott says, thank you. Jose says, Hey, that looks better too. Correct? Greenish says so with the two 10, you are in the money. Now, again, guys, this is giving you all kinds of crazy advantages over the why you're so deep in the money.
Joel, can I, do you mind if I go off on that for just a second, Jeff? Is that okay? All right. I wasn't planning that, but let's explain it just a little bit. I'm going to look at the Greek feta now. Feta is measuring time to K you can think of time decay, like you're paying interest for something. Now we all know the rule about interest.
Those who collect the interest are the people who make the money. Right. I want to pay as little interest as possible. Yeah. If you buy an at the money option, the cheaper option, which all of us, that's the option we're attracted to. We want to buy these cheap options that are at the money or out of the money we're going with these super cheap options.
Why. Yeah, because we're greedy. Let's be honest. That's what it comes down to. We think, oh my gosh, I can leverage myself even more. But when we do that, we're forgetting about what matters most it's controlling your risk. I mean, if you swing for nothing but home runs and you strike out too many times in your portfolio, you've got to start over again.
The name of the game is stay in the game long enough to be able to get that fat pitch down the middle of the plate, hit that home run. Now theta measures how much you're paying every single day to time to K and measures how much you're spending every day on time to K. So if I buy this at the money option on spending 41 cents per share every day now, because it represents 100 shares, I'll spend a 41 bucks a day on this option.
Now, if I spent I'm just gonna. We're just going to base this on the asking price. Guys, we're going to do this math on the asking price. I'm spending, I'm losing 41 cents a day on an option that I spent 1960 to get into. So if I convert that to a rate of decay, I'm paying over 2% a day to time decay. I'm losing 2% every single day, just to the passage of time.
In other words, the stock has to go up enough just to offset. That time decay. Now, if I go around 80 deltas in the money and guys, we could do this math 10 different ways, and it's almost going to come out the same, but I just want to demonstrate quickly why the 80 Delta option in this type of trade is superior down here.
I've got a theta of 30 now. So first of all, the fate is a lot smaller. It's only 30 cents a day as opposed to 41 cents a day. But what I'm most concerned about is what percentage of my investment am I. That's 30 cents a day. I'm losing on my investment that one's got an asking price of 40 to 60,
less than one, 1% a day 0.7% a day. So you can, you've got a choice to make. You can pay 2% every single day, the time decay, or you can pay 0.7% to time too.
Yeah, exactly. Renounced that to 10. It decays slower. I mean, that's a big, big difference. And this is the kind of math, that specific knowledge that Jeff was talking about that we have to understand in order to be able to not only try and get in the market at the right time and things like that, but also know which strikes to you.
Which strikes to not use. So, Jeff, I don't want to get too far down that rabbit hole because I want to speak to that. I don't either. I want to, but I also want the last thing you should say, Joel, the last thing is also gives you that option gives you more exposure to the underlying stock, right? When you have an 81 Delta, for every one point, this stock moves you're you're it's th th the, uh, call is moving 81 cents.
Right. And delete that. Just pointed that out as well in the check. Good job to leave. That is exactly why. But go ahead, Joel. So what I want to do, and Jeff, I'm going to let you talk about the logic because was your trade on Coinbase? But yeah, so this is now, this is the difference between if you asked me, right.
And now a lot of you guys might be shocked. How many times do I buy options and how many times do I sell options? And the majority of my money, right? That the tactical income, the income that comes into my portfolio, 90% of my money comes from selling. Okay. Because in reality, right? The way people lose money and one, and one of the people, uh, said it in, in here before is that they lose money because of that time decay.
And it, you know, now pick a direction is obviously important. And in this type of market that we've been in over the last, I don't know how many years, Joel, five. Pick a direction is key, but there is something that I think, you know, that has helped me and helped me decide on when I buy and what, when I sell.
And that is putting context around volunteer. Right. That is going to help you understand what stocks, what, uh, you know, asset classes you should be buying options on and which ones you would be selling. And Joel, if you go back to the option chain again, I just want to show him one of our little algorithms that we have down there.
You can see next to the IB percentile. We have this thing called volume meter. Now the volume meter is important to me because the whole part of my career, all I want to do is put context around price moves. I want to put context around volatility, especially as an option trader. And you know, when you look at the IB percentile, you can go back and you can say, all right, it's 43%.
I could look at the, you know, uh, the historic and where it belongs, what we created, uh, for me, as I created over the years, it was, I put context around volatility on why I wanted to know. When was there a better time to sell options? And when there was a better time to buy options, and then I put it into a scanner because I wanted to know which stocks I should be buying and which stocks I should be selling options on.
Right. So that vowel meter, if it's on a scale from zero to 10, when anything above five, I should be selling options. That's telling me that implied volatility over the last, you know, 12. Plus, you know, uh, with a bunch of other stuff called standard deviations is all built into this algorithm. And it's telling me that vault, that volatility it's been expanded and what we've tested over the last 20 or less 10 to 12 years, is that when volatility's really expanded, when you sell some type of option, whether that's, uh, you know, a defined risk trade, whether that's naked, whatever the, if you're selling.
The probabilities increase by anywhere between seven and 10% on your success. And you're getting paid more to take on the risk. So why wouldn't you want to know when to sell options and when to buy and when the volume meter is at zero or one, two or three, Right. Volatility is very contracted. And, you know, at that point you should be buying options.
You should be looking for strategies to take advantage of that directional move in, in, in the underlying, I mean, or maybe an increase in volatility and expansion volatility. So understanding where volatility is at, in that moment compared to where it was a week ago. A month ago where it was six months ago, a year ago is extremely important to place in those decisions on whether you should by itself.
Just like what Joel just showed you, why it is important to understand after you know, where the volatility is, understanding what option strike prices you should be going to buy and to sell. And then which one gives you the most bang for your buck based on the risk reward that you have there. So understanding that is so darn effective.
To becoming more consistent when trading options, just that little change in your thought process of saying, where is volatility and Joel, we always, we Joel and I do this example a lot is, and to try to hone this in. And it's when you look at where volatility, right? You could look at the VIX right now.
And the VIX is trading, I think at 18 or something like that. I don't know where, you know, where is exactly right now, but it's still yeah. 17 and a half. Well, prior to the pandemic, right? Volatility was extremely low. Trying to sell options in that type of environment was extremely difficult to make money consistently, right?
That was a time when the market was going up and we should, you should be looking to buy options. But, and the reason I say that is when you go out at the money and you look at the spy prior to the pandemic, and, and I'm doing this really quickly, you know, the numbers might be off. But if I was going to sell an option on the S P Y at the money I've most, maybe I was getting a dollar 52 bucks.
Right. And they involatility increased during the pandemic. And you see that the VIX had this massive. Right. And now you go at the money S P Y you're getting paid $13, $14 to do that. So to sell an option or to buy an option, when would you rather buy an option? You would rather buy an option when it was one or $2.
You'd rather sell an option when it's 13 or $14, especially when you know the math behind it. And you understand that volatility contracts. And volatility expands. And once you start to get this down, it, you, I, it changes the way you look at the marketing use options with inside your portfolio, and it makes you so much more consistent when trading options.
Joel, do you want to add to that? Because I know sometimes I, I go off there, let me just demonstrate let's let's, let's demonstrate the actual numbers so everybody can see just how dramatic this is. But then I want to, I really want to use that trade that you closed out today, the coin trade to talk about.
Um, you know, especially those people who have smaller accounts, how they can use options once they learn and understand them, because the potential is enormous. So yeah. Let me just demonstrate, we've got a back testing tool on this platform that works great. So I'm going to go back to, uh, the summer before the pandemic.
I'm going to go back to mid July, July, 2019. We're in a Goldilocks economy. Everybody's happy. Um, and th oh, ups, I'm still on the VIX. Let me change the spy. Cause that was the example you were using here, but I'm just going to look at the money options one month out just to keep things simple here. Um, whoops, sorry.
I hit the wrong button there. There we go. We'll go to 32 days out. At that time, we just make sure I'm at the right. Oh, I got out of back testing. Sorry, let me try it again.
There we go. At that time, a one month option. If it was a call, you could sell it for four bucks, puts about the same. Uh, you can see the stock. Trading for about 2 98, you're getting four bucks for an at the money call. If you were to go at the, uh, height of volatility, when, when volatility went really, really high back in, uh, oh, well, we'll just do like mid March of 2020.
Let's see what at the money option with a month. Was going for on spy then
$18. So more than four times as much money, four and a half. I that as a, that's a big, big difference. And being able to understand and recognize when options are overpriced or underpriced, by putting context around volatility is absolutely critical. I know you weren't planning on this. Jeff stall. Don't get angry at me later, but I did want to use this coin trade.
Yep. No, do it. And I think it's really important. It's a beautiful, beautiful example. So can I set it up? Absolutely. So, but understand it guys and understand what you know, we'll walk you through this trade and, uh, and why we've been so consistent and just to add a little bit more of, of a. The consistency of using and understanding why volatility is important and understanding the black Sholes model is because, and I don't think we've stressed this Joel, and I know we're running out of time here, but it's really becoming the house right.
For all, most of my career, I felt like I was one of these guys walking into the casino, pulling the lever and never having that edge. So by having the tools right. And understanding the backtesting and the knowledge that we had, the data that we have, where all of a sudden becoming the house we're putting the, the, the odds in our favor and coin is a perfect example of understanding where I could have still been wrong about direction here, right.
When I put this trade on, but I, and still make money. Which blows my mind for a lot of people. I don't think you get that is the fact that, you know, I, I went out and go ahead, Joel, you can, you can walk this way. So on the 15th, Jeff sent out alert an alert to all our subscribers. You said, Hey, sell Coinbase.
And it's a trade called a bull put spread to 15 to 20. So this was the day right there. Jeff basically puts a trade on that says, I don't think the stock is going to be below this line. In 45 days, it might dip below it temporarily, but in 45 days, it's, it's going to be above that line. Now, when Jeff put this trade on, uh, if I got these numbers a little bit wrong, I'm sorry.
You have to, you can correct me. It was a $1 return for a $4 risk, which is a 25% return on risk. Now what that means in real dollars is per $400. That's how much the trade would cost you in your account is $400. You are leveraging $24,545 worth of stock. And if the trade works out, you could make as much as a 25% return in 45 days.
So Jeff walk us through now that I've kind of done the numbers on it. Walk us through what you saw on this. Why was this alert? Well, one of the things that, you know, we were looking at in everybody and anybody, I have a, I do a YouTube channel every month. And I, you know, I do four days a week and try to give out some kind of, you know, what I'm seeing in the market, some trade ideas.
Um, and one of the things that we saw was the relative strength compared to big corn. Right. And that was, you know, you know, there's certain stocks that we follow. And when I go through the volume meter, it had a score of six and a half on the volume. Right. So it had that big down move and, you know, initially I put the trade on and then I added to the trade a few days later because of the fact that there was such relative strength compared to Bitcoin Bitcoin looked like it was going to break down under 30,000.
And as soon as it did. Not only do we buy a little Bitcoin, but we add it to our coin position there because of that relative shrimp. And I knew, you know, the worst case scenario was I had a defined gross trade if Bitcoin dropped and went down to 25,000 or went down to 20,000, I defined my risk and the key guys, and we're showing one example.
But the key to all of this is remember you're not trading too big because it's not about one trade it's about, it's about finding multiple trades. Right because I'm using the probabilities and statistics, but I'm also using our ability, the ability that you've learned from. That I've learned through my years of trading, right?
Why I call ourselves tactical income is to look at stocks like Coinbase, and to look at the NASDAQ when it gets overextended or, uh, you know, apple and Amazon, when it gets to certain, you know, um, you know, at certain points and just use it on any different and the beautiful part about it is being able to use options on anything.
Whether it's the Aussie dollar or it's oil or it's stocks. And that's the beautiful part. But by adding the understanding, the volatility, right. And understanding that, you know, that you're using probably ability in statistics and be in the house, it increases your chances. Of success and your probability of profit.
And when you, when people say, Hey, what does that mean? Well, our hit ratio last year, I mean, we sat down over 200 and something trades. I don't even know the exact number of how many trades that we we've sent out, uh, over the last, I guess, 14, 15. And we have an 86 or 87% hit ratio. And the reason why is because of the fact of the probability and statistics and the volatility using the common combination of those two and being the house, right.
There's not many people out there that can say they have an 86% history showing that it's not that I'm so freaking great. It's a fact that we're teaching people a process. On how to become a house and using certain tools and techniques to be able to increase their profitability and their probability of success.
And when you, you, um, go out in time, right? That's over 14 months. Now, imagine that hit ratio over five years, over 10 years. Right. That is where you build wealth. And I saw someone saying it in the chat room was how options, you know, by having a combination of the two is extremely key, right? Being able to understand when the buy options and when to sell and being the house is so damn important.
And that's what we like to teach everybody is how to use options with an edge.