Raw Transcript: Options Trading | Capital Allocation for Account Size

All right. So, the best of part one. >> Beautiful. >> Cool. >> Let's do it. >> Uh, so the first one we put on here is navigating capital allocation and buying power reduction. This was on in February um of this year. And so, uh, you know, what we talked about was obviously buying power. Some traders are curious why buying power in their naked position positions such as short puts, short calls, strangles can suddenly change in buying power, often increasing even when the underlying price stays the same. And so there's a lot of factors that go into buying power from volatility to time to um what product you're trading. Futures have a a whole different um set of rules that that uh go towards their margining requirements. Um but aside from stock movements, the next big reason for the buying power fluctuation is the increase in implied volatility. A quick spike in IV can boost the option premium which in turn raises the buying power. And we give you an example here on this next slide. >> So uh we looked at Nvidia and the Nvidia example demonstrates how stock movement and changes in implied volatility affect daily buying power fluctuations. And this was just a one standard deviation strangle in February. um on Nvidia. And so we looked at the stock price and obviously there was a big move in the stock which contributed to is part of the reason why volatility expands. IV doesn't just expand out of nowhere. It usually happens on some sort of event or big move in the stock. Um but you can see the margin requirement, the buying power requirement uh increased into this move and that's a function of volatility and and price as well as typically when you have a stock that goes up margin requirements will also expand because the all the numbers in the calculation get bigger. Right? The stock price is a is it a piece of the margin requirement calculation and when that piece goes up it's going to increase the buying power. In this case, Nvidia went down, but the implied volatility went up by so much more than that that function that the buying power increased along the way. So, you should certainly keep in mind that buying power can and will change. Uh you can't really play for this big of a change. It's not like you put on a trade and you say, "Oh, well, it only uses 2,000 right now. I expect it to go to 5,000 at some point." But you should expect it to go to 2500 or 3,000. I mean, these this is an example of why we keep capital on the sidelines, you know, just in case for these events, right? And this is, you know, Nvidia during this period of time was probably not the only stock you had that was experiencing higher volatility. I mean, this was right in like the kind of middle of our our down move in the start of the year, you know, like this was just before >> the kind of big move in April. And so, >> you know, this is an example of why we keep capital on the sidelines and and the you know, not being overleveraged on positions. >> Very good. Um, and then so some of the underlyings that we highlighted here, we just gave you like a batch of stocks that were really set. I think these are kind of um uh groupings that you can see a correlation to in terms of the the account size, right? So your smaller size accounts, you're looking at lower price stocks. You have like a Snapchat in there. SoFi was in like teens. silver, which I don't think uh applies anymore uh because silver is quite the volatile asset here, but it SLV is small enough to trade. You have like lower volatility stuff like EM and TLT in there, Bank of America. Um and then you have like, you know, some of the higherend the higher towards $100 price range stocks like an Uber that's in the tech space. These are like your smaller sized account trades where you can do naked positions. In our Johnny Trader account, we sold puts in Intel. That was kind of our naked position. We used ETH. We did like a wide put spread in EA. The rest of our trades are more uh risk defined trades. And that's because there's only a small number of stocks that you can really be naked in a smaller sized account. when you get into the medium account, you know, you can get into your targets, your SMH, gold, um, IBM, you you can get a little bit more diversified there. And then when you get in the larger sized account, you can look at S&P and, you know, some of the bigger stocks as well, >> right? I have a reverse jade lizard on in silver SLV >> that I put on when silver was, it's trading 69 now. let's just say close at 68 or 67 and a half uh because it probably down another dollar on this uh spread or maybe even a little bit more. Um I put on when silver was trading around uh 6061. So if I was trading a silver contract, I'd be down around $8,000 or so. If I was doing a strategy similar to this one, like a reverse jade lizard in uh in in a silver product like for/sil or something like that, I'd be down uh around $6 to $9,000. In SLV, I'm down 300 bucks. >> Yes. >> I mean, >> manageable. >> Yeah. I mean, you know, >> for any sized account >> stinks, but Yeah. Right. Right. That's That's how you get small. >> Yeah. You didn't you didn't expect it to be $300. >> No. And I'll probably roll up the uh put spread uh in SLV today. Uh >> and that'll be the top 10. >> That'll be the top because I just can't take it anymore. Y >> I know we're getting bailed out on the on the gold move here cuz we're we're still long that gold silver ratio. So, we're long two gold which are, you know, let's just call it like 3 and a4%. >> Yep. >> Together, cuz you're getting about 1.7 on each, we'll say 3.4%. So, the spread has moved about a full percentage point, which is about $1,000. >> Yep. >> Yeah. >> $1,000 per per percentage move between the two gold versus one silver. Um, so it's a big big contract. Yes. And it's been moving. Yep. Yep. >> Next slide here. Um, so it's critical to allocate capital wisely into options positions. Typically, we should keep our total committed trading capital around 30 to 50% when Ivy is low. You know, you can skew this to your liking, right? And to your account size. In a johnny sized account, it's really, really hard, if not impossible, to stick to that metric of 30 to 50%. because you just don't have the capital and everything that you're trading is riskdefined, right? So, or for the most part risk defined. You might have those oneoff naked puts in Intel, but you're not really playing for Intel to go to zero. That's not like in your realm of of of possibilities here. Your spread trades, you know, your short call spread in the diamonds or your iron condor in the Q's, those can certainly go to, you know, full loss because they're relatively tight spreads. So you have to keep in mind that you know your risk tolerance is going to play into this metric. Your account size is going to play into this this metric. If you're on the me medium to large size account this is probably a good place to be. We're in this range if not more than that. You know we're probably about 30%ish right now allocated around. >> Yeah. Yeah. >> It's a good spot to be when volatility is low you know in that realm. Then you can ramp up when volatility gets high. When IV is elevated, traders have the opportunity to take larger positions to capture capture higher premium. However, any capital allocation exceeding 70% should be carefully monitored as the number can quickly expand if the market moves against the portfolio. Um, when you get it, you know, this kind of answers the question that we always get of like what do you do with your extra cash? It's just being wasted on the sideline. It's not being wasted when you experience an April type move where you know your positions expand, you know, they double basically and if you're 30 or 40% allocated, you go to 80%. And that's, >> you know, that can happen. And so, and you'll see it here in the in these metrics of like when IV is high using 50 to 70% of your capital, a lot of that is going to come dynamically because stuff's going to go against you and your 30 to 40% allocation might go to like 60. >> That's not good. >> That's not good. >> Get overweighted. >> Keep size in check. Couple takeaways there and then we'll get to the next one here. We're basically doing like two option jobs today. So, we [clears throat] have like four research segments today cuz we're doing two recaps. >> Have two in each. >> Very nice. >> Got to get your thinking cap on on Monday. And we have Jim. >> Oh my god. I don't know. >> Nothing says Monday like Dr. Jim. >> I don't know if I'm going to be able to make it. Buying power can fluctuate significantly in undefined risk strategies due to the stock price and implied volatility changes unlike defined risk strategies where buying power is more stable. It is stable. It's defined risk. Uh if you're trading options on equities, futures will have a a dynamic span margin uh that can change. Buying power is mainly determined by the underlying price out of the money strikes distance and the option premium with strangle buying power based on the higher buying power of the naked put or call. So um you know with strangles you you typically see a little bit lesser buying power requirement. uh because you're collecting more premium, you're usually further out of the money. You can only lose on one side of the of the trade versus um uh you know, just being on one side of the uh of the trade. Allocate capital wisely. Maintain around 25% in low IV and then you know when you get into the higher IV regimes, you can get up to the 50 60 range. >> Beautiful. Good job out of you. Good job out of the team. Good job. >> We got one more. >> Okay. We have a whole note. We We spent a lot of time on that. I'm sorry. Go ahead. Go ahead. We'll go through this quick. Leverage liquidity for lasting growth. This was in March. Um, >> next slide here. So, we talked about tight bid ass spreads. I told you we got to have our thinking caps on today. >> You're right. You're right. >> On a Monday, the team really with no vanetta. >> It's amazing. >> This is this they've lit the fire underneath us. >> Okay. Um so one of the core aspects of the of liquid markets is a tight bid ask spread. Uh it's it's it is the price discrepancy between the highest willing buyer which is the bid price and the high and the lowest willing seller the ask. Uh it effectively rep represents the slippage between where we buy uh or sell positions by focusing on the most liquid actively traded stocks. We are able to minimize the cost significantly. We talk about u bit you know tight bit ass spread the liquidity all the time and really it's just a you know if you think about the the amount of time that you plan on trading and and uh being in markets which is for most people is forever in some way or another um and should be forever >> when you're buy you know when your spreads are five or 10 or 20 cents wide on everything you do for the rest of eternity it's a lot of value that you're just like kind of pissing away tighter ass spreads allow you to just tighten that up. Like you want to be in stuff that you can buy and sell at basically the same price. It allows for a lot more transparency of where your positions are at. You know, understanding of of profits and losses on your positions. If something's marked at 0 cents and a dollar, you're going to see prices move around. You might get filled at at something less advantageous. Uh you might be buying something at at at a worse price. Bitass spreads are are the one passive thing that you know just trading tight markets is going to save you a couple dollars on every single one of the trades that you do in that. >> Perfect. Agreed. And those add up. We've done segments where we show how much that cost you per year. It almost makes it impossible to be profitable even if you're directionally right. >> Yeah. >> Sports betting is a 10% slip. There you go. There you go. Good example. >> A lot. >> Mhm. [clears throat] >> Uh next slide here. So just a quick little thing on just you know activity and and you know you have tighter spreads you can be more active in that underlying and and you'll get better fills near mid price. Um next slide here. So analyzing five known highly liquid underlyings, we can conclude that the underlying is liquid if the spread is around 1 to 2% of the options mid price. And so if you're looking at a percentage um you know typically we say onetenth of 1% of the of the stocks price. So if it's a $100 stock and the bid ass spread is 10 cents wide, you're you're in a pretty decent spot there. it. Obviously, you want it to be penny wide and a lot of these stocks listed here are all going to be penny wide, especially penny wide on the the shares themselves, but the options are going to be, you know, one, two, three pennies wide here. So, um, you know, individual stocks though tend to have wider spreads and that's a function of higher volatility, generally less liquidity. I mean, something like SPY is one of the most actively traded uh underlyings in the market. So, you're going to have more liquidity there than, you know, Coinbase. >> Yeah, it's not a not a shock there. >> Correct. >> Uh, next slide here. So, again, this is just looking at volume and open interest. You know, you typically want to see a couple thousand contracts minimum across the the order chain. It doesn't have to or the uh option chain. doesn't have to be on every single strike, but if you're seeing that most strikes, especially those at the money strikes, have a 100 contracts or 150 contracts traded, they're probably not that liquid. I mean, just think of that from like, you know, a a a counterparty standpoint. If there's only a handful of people trading, you're going to have wider bid ass spreads because that that price discovery is going to be much wider. There's only a handful of of of people trading it. when you have thousands of contracts trading in volume and open interest, you know that that's a relatively liquid underlying and you should look at the at the money strikes and kind of look at those metrics that'll tell you um you know where you should be trading and if you look at something like a Tesla or an Apple or SPY or Q's, you're going to see a thousand contracts on every single strike. I mean all of them. So you you'll see this across the board. Uh next slide here. Uh we also have a bunch of built-in watch lists. If you go to the liquidity section in the PLA platform, we have a bunch of of names in there that are are relatively liquid there. Couple takeaways and then we'll uh get to the opening bell here. So the bid ass spread is the difference between this the sell and the buying uh prices of stocks and options. Ideally as narrow as a penny can't get any less than that. Um, a narrow bid ass spreads suggest fair pricing and easier trade navigation while wide spreads indicate an illquid market with unclear pricing. So wider spreads, it's just harder to trade that option or at least find the fairer value of that option. Option volume reflects the total transactions at a specific strike. Um, while stock volume shows the amount of shares that are trading. Volume in the options is per day. Open interest adjusts at the end of the day and it's just open contracts. Uh whether they're long or short, it's just open contracts. Open interest um is only in options. It's the number of open contracts per strike. High volume and and high open interest generally indicate higher liquidity and a narrow bid aspre as um as do underlyings with many expirations. When you see an underlying that has weekly expirations, it generally means it's probably more liquid than something that only has monthly expirations. >> Great point. Great point. And a lot of times if they have those weekly options, you might notice that the monthly options are a little less liquid, especially when you go to um uh some of those stocks that uh well, go through the chain and see. You'll see that the the at the monies or the uh earlier ones have more liquidity than the monthlies. where if you look at like an S spy, it'll be pretty even or maybe even skewed to the to the front part, the daily options, because those are going to expire, but the monthlies will have a lot more than the weekly options. Good job out of you. Good job, team. And you are right. They did uh do two option giants in one there. >> I think we have two market measures, too. >> Beautiful. Let's take a quick 90 second break and come back. We got the opening bell, which we've been waiting for right after this.