PDS TRADER MANUAL. Instructions for using the Payday Stocks Trader software Quantum Trading Technologies. PDS Trader Manual 1

Transcription

1 PDS TRADER MANUAL Instructions for using the Payday Stocks Trader software 2013 Quantum Trading Technologies PDS Trader Manual 1

2 CONTENTS Getting Started 3 Log in to the PDS Trader 3 Retrieving Market Data 4 Strategy-Types.5 Using the Tables.5 Column-Headers..6 Sorting.8 Filter Editor..9 Tracking Trades 10 Live Trading...11 Placing an Order.. 11 Open Orders.14 Open Positions 15 Orders 15 Menu Strip 16 Opportunities. 17 Covered Calls 17 Synthetic Covered Calls (Naked Puts) 19 Debit Calendar Spreads..21 Credit Calendar Spreads.24 Credit Vertical Spreads 26 Debit Vertical Spreads.27 PDS Trader Manual 2

3 Getting Started- Log in to PDS Trader When the PDS Trader software is launched, the first window to appear is the "Login" Window. The "Login" window allows the user to log into a live JunoTrade account, enter Non-Live mode, or select "Cancel" to close the program. JunoTrade To log into a Live JunoTrade account, enter your JunoTrade User Name and Password. Contact Junotrade for assistance with User Name and Password. Enter the User Name and Password as shown below, then select "Login" to access the PDS Trader Non-Live Mode To enter Non-Live mode, select, "I don't have a trading account with JunoTrade" and select "Login." PDS Trader Manual 3

4 Getting Started- Retrieve Market Data After logging in, the PDS Trader will open to the "Update Data" tab by default. Select the "Update" button to begin retrieving the market data. Once the "Update" button is selected, the Progress Bar will begin to fill. The amount of time the process takes to complete depends on the user's internet connection speed. During the updating process, the PDS Trader collects data for options within two Strike Price intervals of At-The-Money. When the "Update" process is completed, the Progress Bar will be completed. The PDS Trader displays how long it took for the "Update" to complete- By default, the PDS Trader will automatically update the data every 120 minutes. To change this, select "Configuration" in the Menu Strip, change the "Auto update" field as shown below, then select "Save." PDS Trader Manual 4

5 Getting Started- Strategy Types Overview The PDS Trader software displays opportunities for Covered Calls, selling Puts, Debit Calendar spreads, Credit Calendar spreads, Vertical Credit spreads, and Vertical Debit spreads. Selecting one of these tabs will display opportunities for that strategy type. Once a strategy-type is selected, a variety of Expiration Dates will appear. In the example below, Covered Call opportunities for the options that expire on are shown- Selecting the " Call" tab displays opportunities for options that expire on , etc. Expiration tabs will clarify if they are displaying Call or Put opportunities. For Calendar Spreads, Expirations are listed and compared to each other as shown below- In this example, the PDS Trader is comparing the Calls compared to the Calls. PDS Trader Manual 5

6 Using The Tables- Column Headers The PDS Trader shows opportunities in a table of rows and columns. Each strategy type has unique column headers. Fields that all strategy-types contain are listed below, followed by a complete listing and explanation of the each strategy- Symbol-The underlying stock the option is based on Price- The price of the underlying stock Change %- Movement percentage of the underlying stock since the previous day's Close Earnings Events- Upcoming Earnings Events dates will appear here * Earnings Events dates colored in dark-red mean that an Earnings Release is scheduled to occur between the current day and the expiration date of the option. Dates colored otherwise represent a Conference that will occur between the current date and the expiration date. *Extrinsic Values are shaded green if they are out-of-the-money, orange if they are in-the-money. Display Calls/Display Puts: Expiry- Expiration date of the option the opportunity is based on Strike- Strike price of the option that the opportunity is based on Strike Distance- The distance the underlying stock is away from being At-The-Money Volume- The volume of the option the opportunity is based on Ext Value- The extrinsic value of the option. Max Flat Gain- The maximum profit/gain to expect Protection- The amount the market can move against you while you remain break-even Debit Calendar Spreads: Strike Distance- The distance the underlying stock is away from being At-The-Money Strike- Strike price of the option that the opportunity is based on Sell Exp- Expiration date of the option to be sold Buy Exp- Expiration date of the option to be purchased Sell Price-Price of the option to be sold Buy Price- Price of the option to be purchased Debit- Difference between the Buy Price and the Sell Price, maximum risk Spread Ratio- Sell Price divided by the Buy Price Sell EV- Extrinsic value of the option being sold Buy EV- Extrinsic value of the option being purchased EV Ratio- Sell EV divided by the Buy EV PDS Trader Manual 6

7 Credit Calendar Spreads: Strike Distance- The distance the underlying stock is away from being At-The-Money Strike- Strike price of the option that the opportunity is based on Sell Exp- Expiration date of the option to be sold Buy Exp- Expiration date of the option to be purchased Sell Price-Price of the option to be sold Buy Price- Price of the option to be purchased Credit- Difference between the Sell Price and the Buy Price, maximum reward Spread Ratio- Buy Price divided by the Sell Price Sell EV- Extrinsic value of the option being sold Buy EV- Extrinsic value of the option being purchased EV Ratio- Buy EV divided by the Sell EV Vertical Credit Spreads: Expiry- Expiration date of the option the opportunity is based on Sell Strike- Strike Price of the option that is being sold Buy Strike- Strike Price of the option that is being purchased Sell Price- Price of the option to be sold Buy Price- Price of the option to be purchased Credit- Difference between the Sell Price and the Buy Price, maximum reward Max Risk- The maximum risk of the trade Profit Risk Percent- The Credit divided by the Maximum Risk BE Move- The percentage movement the market needs to make to be at Break-Even BE Level- The price that the market needs to reach to be at Break-Even Vertical Debit Spreads: Expiry- Expiration date of the option the opportunity is based on Sell Strike- Strike Price of the option that is being sold Buy Strike- Strike Price of the option that is being purchased Sell Price- Price of the option to be sold Buy Price- Price of the option to be purchased Debit- Difference between the Sell Price and the Buy Price, maximum risk Max Profit- The maximum reward of the trade Profit Risk Percent- The Maximum Profit divided by the Debit (Maximum Risk) BE Move- The percentage movement the market needs to make to be at Break-Even BE Level- The price that the market needs to reach to be at Break-Even PDS Trader Manual 7

8 Using The Tables- Hiding/Showing Columns Hiding Columns Due to the amount of information available, there will be times when it is necessary to hide columns that are not needed. To hide a column, right-click the column-header (Change %, for example) and then select "Remove This Column." The column will then be removed from the table, but is only hidden from view. Adding Columns To restore hidden columns, right-click any column-header and select "Column Chooser." A window will appear in the bottom right of the PDS Trader- Right-click on any of the items listed here and select "Show This Column" to be able to view the column in the table. Using the Tables- Sorting After running an update, the data needs to be sorted to find opportunities more quickly. Sorting in the PDS Trader is very simple. Click any columnheader, such as "Change %" and the table will sort, click the column-header again to sort the opposite direction. For "Display Calls" and "Display Puts" the primary sorting method is Max Flat Gain from highest to lowest. For "Debit Calendar Spreads" the primary sorting method is EV Ratio from highest to lowest. For "Credit Calendar Spreads" the primary sorting method is Spread Ratio from lowest to highest. For both Debit and Credit Vertical Spreads, the primary sorting method is Profit: Risk Percent from Highest to Lowest. PDS Trader Manual 8

9 Using the Tables- Filter Editor The Filter Editor feature allows users to only view opportunities that meet the filter requirements. To access the Filter Editor, right-click any columnheader and select "Filter Editor " Due to the nature of option data, the Filter Editor comes with default filters already in place to catch any data that may be incorrect. To remove a filter condition, click the "X" to the right of the condition, as shown below- Always select "Apply" to apply the filter requirements to the PDS Trader. To add a condition, select the + symbol next to "And" in the upper-left corner of the Filter Editor- Select the value in the brackets [Max Flat Gain] in the image above, then change it to the desired field. Select the "Is less than" string in the above example, then all of the operators will appear (Is greater than, is less than, is between, etc.). Enter all values in Textboxes as numbers, not percentages. In this example, entering.05 and selecting "Apply" would display all opportunities with a Max Flat Gain greater than 5% For a detailed example of using the Filter Editor, use the following link- PDS Trader Manual 9

10 Tracking Trades- To access the tracking feature of the PDS Trader, enter Non-Live mode (see page 3). Tracking is available for the "Display Calls" and "Display Puts" sections. Once a desirable opportunity is found, select "Track" in the farright column. A new window will display, stating "Do you want to Track this trade?" Select "Yes." To view the performance of the trades that are being tracked, select the "Tracking Call" or "Tracking Put" tab next to the Expiration tabs. The "Tracking" page displays a large variety of numbers related to the trade that is being tracked, look to the "Net PL" column to the far right to see the performance of the trade so far. To update the Tracking statistics, select "Configuration" and then adjust the "Update Tracking Trades data at every " field as show below- With this configuration, the trades that are being tracked will update every 10 minutes. Once a trade that is being tracked expires, the trade is moved into the "Tracking Closed" tab and can be viewed there. PDS Trader Manual 10

11 Live Trading- Placing an Order After signing into Live mode with a JunoTrade account (see Page 3), users are able to place orders directly from the PDS Trader software. Once an opportunity is found, select the "Trade" button on the far right of the PDS Trader.Selecting the "Trade" button for any strategy will display an order box already filled in with the necessary details. Display Calls Selecting "Trade" in the "Display Calls" section brings up a box with Covered Call details already filled out. "Convert order to" will allow the trade to be changed from a Covered Call to selling a naked call, or only buying the underlying stock. "Order Type" allows the user to enter the order as a Limit or At Market. "Order Expiry" allows the user to select between a DAY order or GTC. "Cost Basis" is the Stock price minus the Bid "Position Effect" states whether this order is to open or close a position. Select "Minimum Call Value" to require the Call to be above a certain value before entering the trade. Change the "Quantity" in each section to increase the lot size to be traded. The "Strike" price is the Strike Price of the option being sold. "Buy/Sell" states if the option or underlying is being bought or sold. PDS Trader Manual 11

12 Display Puts Selecting "Trade" in the "Display Puts" sections brings up a box with details for selling a put already filled out. "Buy/Sell" states if the option is opening or closing a position. "Quantity" determines the amount of options being traded. "Symbol" states the stock ticker of the option being traded. "Strike" is the Strike Price of the Put being sold. "Call/Put" states that it is a Put that is being sold. "Expiry" shows the expiration date of the option being traded. "Price" is the option price and is used with the Limit "Order Type." "Order Type" controls whether the order a Limit order or At Market. "Order Expiry" allows the user to select between a DAY order or GTC. PDS Trader Manual 12

13 Calendar Spreads and Debit Spreads Select "Trade" in the Calendar Spreads or the Vertical Spreads and the Order Entry box will display- "Position Effect" determines if it is a Debit or Credit trade and whether or not it is opening a new position or closing an existing position. "Order Expiry" determines whether or not the order is DAY or GTC. "Amount" is for Limit orders and determines the necessary spread amount. "Order Type" allows the user to enter the order as a Limit or At Market. "Qty" determines the number of positions to trade for this order. PDS Trader Manual 13

14 Live Trading- Open Orders The Open Orders tab only shows orders that were placed, but have not been filled. "Single Leg" orders are orders from the "Display Puts" section. "Covered Call" contains orders from the "Display Calls" section. Note the "Cancel Order" button, which cancels the order so that it is not filled. Once an order in the "Open Orders" tab is filled, it is moved to the "Open Positions." tab. Any Exit limit orders that are not filled will appear in the "Open Orders" tab until they are cancelled, expire, or filled. PDS Trader Manual 14

15 Live Trading- Open Positions The Open Positions tab shows order that have been filled and are currently open. "Single Leg" orders are orders from the "Display Puts" section. "Covered Call" contains orders from the "Display Calls" section. The "Exit" button allows users to enter exit orders for either "At Market" or with a "Limit" order. Limit orders will be placed in the "Open Orders" tab until filled. Open positions that are completely closed will be removed from the "Open Positions" tab. If an order is partially closed (for example, 5 out of 10 options were closed), the exit price of the 5 closed trades will be displayed in the "Exit Price" column. Live Trading- Orders The "Orders" tab connects to JunoTrade and displays all orders that are placed in the account. Check the "Info" column to the far-right for error messages if an order is not being accepted. PDS Trader Manual 15

16 Menu Items- Selecting "File" displays the ability to Backup Data. This can be used to transfer database files from one computer to another computer, so that Open Orders and Open Positions will display on another computer's PDS Trader. After backing up the data, transfer the data file to the other computer, then click File-Restore Data on the other computer and restore the data. Open Orders and Open Positions will now be available on the PDS Trader of the new computer. File-Exit closes the PDS Trader. The "Configuration" feature is covered in page 4 (updating date) and page 10 (updating Tracking data). Selecting "Calculator" opens the Windows Calculator program. Selecting "Send Error Log" will produce a new box requesting the name and address of the user (for later contact), and steps to reproduce the bug or error. This is useful in resolving any issues that may exist within the software. PDS Trader Manual 16

17 Opportunities- The "Opportunities" section of this manual is only for information purposes as to what Quantum Trading Technologies, Inc. looks for in opportunities. Users must do independent research to find opportunities, this section contains a few of our basic guidelines for what to look for in opportunities initially. Some of the guidelines in here are circumstantial and are only details for what we look for in trades. For column-header definitions, read pages 6-7 of this manual. Display Calls and Display Puts The "Display Calls" section is applicable to trading Covered Calls, or selling naked calls, while "Display Puts" is for selling naked puts. Selling naked puts is essentially the same as a covered call, only it requires one less transaction. The primary sorting method for both sections is Max Flat Gain, sorted from highest to lowest. "Display Calls" and "Display Puts" have a limited profit potential, so this value shows whether or not this limited profit potential is worth entering the trade. The "Protection" column shows how much the market must move against the trade in order to bring the trade to breakeven. This value, coupled with Max Flat Gain, shows the potential reward of the trade and the protection associated with that reward. Because many of the best opportunities are driven by conferences and earnings, view the "Earnings Events" column to be aware of any upcoming events that may increase volatility during the trade. Using the Filter Editor (see page 9), users may add a "Strike Distance" requirement for the opportunity to be within, for example, 2% of At-The-Money. The Extrinsic Value column is color-coded based on whether the option is In-The-Money or Out-of-the- Money. Green represents In-The-Money options, orange represents Out-ofthe-Money options. Covered Calls- Covered Calls are simply having a long position in a stock and a short call option that brings in premium. The effect of this is to lower your average cost of the stock. For example, PDS Trader Manual 17

18 If a person is long QCOR from and short a QCOR Call from 1.00, the Cost Basis is $ This means the person is essentially long the stock at a Discounted Price. Before viewing Covered Calls as an answer-all to trading, it is important to know the largest drawback. This Discounted Price comes with a cost- the profit potential of the long position. In the QCOR example, that person cannot make more than 1.00 on this position, even if QCOR increases by 1000%. While the potential profit is capped, the potential risk is much larger. The loss potential is equal to the cost basis. In the QCOR example, the maximum risk is $25.50, assuming the stock goes bankrupt. This is important to understand from the standpoint of trade-size and commitment to the strategy. Large losses will come. You will lose money on the way down, and you will not make it back as fast on the way up. The goal is a long-term, consistent approach. The 2 keys to success with covered calls are 1) Risk management for longterm commitment and 2) Finding the right opportunities. A unique strategy that covered calls offer is the ability to sell calls week after week for months while holding the underlying, which can eventually bring in the price of the stock. When searching for Covered Calls opportunities, we look for a 3%-5% Max Flat Gain as the minimum standard. Rarely do we choose an option with less than a 3% potential return if the market is flat. This is certainly not a universal rule, as there are plenty of examples for when a small return is worth it. For example, a stock could have only two days until expiration and have a 2% Max Flat Gain. Another example for taking advantage of small potential returns is trading a covered call in a very stable, non-volatile market. Over the long run, you could do better with small potential returns over non-volatile stocks than with trading larger potential returns in volatile markets. Another rule we use to filter out dangerous opportunities is to never get into a position where the volatility is so high that the risk is not worth the reward. Sometimes there is some subjectivity to that, but sometimes it is obvious. One general way to look at this is if the daily average range for the last several days exceeds the premium we can bring in, or it exceeds where our breakeven level is, then we generally pass on the opportunity. PDS Trader Manual 18

19 The last rule is that the stock must not be making an intermediate or longterm high. This may factor in adding to volatility in many cases, from anticipating a new high or a short-term retracement. There are times when an impending earnings report or other major announcement will impact the market. These sometimes drive the price of the options to significant levels. In terms of money management, we look to allocate no more than about 20% of the total amount allocated toward covered calls toward each individual trade. For example, if $10,000 is allocated toward covered calls, we never have more than $2,000 to any given trade. The $2,000 allocation in this example is based on the price of the stock. A strict adherence to this rule would mean no stocks much over $ It is unlikely that a stock will go bankrupt and drop to zero during the short time you are playing the stock, but you always have to prepare for the worst case scenario, regardless of how unlikely. With this method, a 50% loss is only 10% of the total account. Synthetic Covered Calls (Naked Puts)- In order to attain maximum profit on a sold put, the market must be at or above the strike price at expiration. Selling a naked put is very similar to trading a covered call, so please review the Covered Calls explanation to have a firm understanding of the basic principles and statistics that we look for. With a Covered Call, the Cost Basis is the combined long stock price minus the premium brought in on the call. A naked put can achieve the exact same thing, only with one less transaction. The risk and profit potential with a naked put and a covered call are the exact same, only with naked puts you do not have to overcome to spreads to get the price. In fact, all things being equal, we default to selling puts. Most of the time, puts are a better choice from the standpoint that there is almost always a little extra premium built into put options that comes from fear of a market crash. This is not always the case and varies from stock to stock, depending on what is going on in that stock. As a side note, many IRA or other unique accounts will often not allow trading naked puts, in which case a Covered Call can usually be utilized. The best way to deal with losses is to let them run their course and simply exit on expiration day, or allow a put to be assigned if the next expiration of PDS Trader Manual 19

20 calls is worth placing another covered call. Our intention when entering a trade is to always continue to play the covered calls while the calls provide the proper profit potential vs. risk potential. Several times we have been assigned a Put option, only to be able to turn around and sell a call at the strike and turn a loser into a winner. Sometimes that is not available, and it is just better to exit the trade, take the loss, and move on to the next opportunity. This sometimes means accepting bigger losses. An alternative to letting a loss run is to exit when the price of the underlying stock reaches the breakeven point. This will still produce a loss, but the loss will at least be mitigated. The problem with this exit strategy is when the stock gaps past the breakeven level and you are still forced to take a larger loss. Accordingly, at no time should you think that a larger loss is not going to happen eventually. It will, which is why it is important to prepare to commit long-term to this strategy to expect to profit from it. PDS Trader Manual 20

21 Opportunities- Debit Calendar Spreads Debit Calendar Spreads involve selling a near expiration and buying a far expiration. Since the price of the option purchased will always be greater than the price of the option being sold, a Debit is created. This "Debit" value is the maximum risk of the trade, while the Sell Price can be viewed as close to the maximum reward. The primary sorting method is the EV Ratio (Extrinsic Value Ratio), which is the Sell EV divided by the Buy EV. This shows how closely related the extrinsic values of the options are- the close, the better. For short-term opportunities, look for an EV Ratio around 70% or greater. For long-term opportunities, the EV Ratio expectations can be lowered. Debit Calendar spreads have a clearly defined maximum risk because the spread cannot (theoretically) go below 0, and they require very little capital. If trading multiple options, an exit strategy can be to exit half of the positions at a 100% profit to ensure the trade will at least end at break-even. Debit Calendar Spreads are very enticing and rewarding for a few reasons. They provide limited risk, bigger potential wins than losses, they work in bull or bear markets, and they require very little capital. After entering a Debit Calendar spread, if the spread increases you will profit, if the spread decreases you will incur a loss. The maximum risk on the trade is the entry spread. The maximum profit is the value of the short option. In order to achieve the maximum profit potential, the underlying stock must be At-the- Money at expiration. However, that profit potential will be diminished by whatever amount the long option has decreased by. For calls, the further the stock goes out of the money on expiration, the greater the loss will be on the long call. It is also important to watch out for earnings or news events that will cause the stock to move out of the money. The news combined with market movement causes the extrinsic value to quickly deflate. However, this could work to your advantage as the spread will often widen during these large moves. This occurs because the extrinsic value of the nearby option can move more quickly than the further away option. While there are many exiting strategies for these spreads, one that we frequently use is exiting half of the position at a 100% profit. This will ensure that the trade will at least close at break-even. PDS Trader Manual 21

22 Debit Calendar spreads can be entered when the options are At-the-Money, In-the-Money, or Out-of-the-Money. The following details are regarding entering a spread while it is At-the-Money. Entering At-the-Money Spreads The reason to look for At-the-Money spreads is based on extrinsic value. With Out-of-the-Money spreads, 100% of the option value is extrinsic value. However, that does not mean that the extrinsic value is the greatest it can possibly be. With At-the-Money spreads, 100% of the option value is extrinsic value and the options usually cannot have any greater extrinsic value. When it can have a greater extrinsic value, it is only by a very small amount. At-The-Money spreads have no intrinsic value. Once an At-the- Money spread is entered, it can stay neutral, go Out-of-the-Money, or go Inthe-Money. Assume, for example, a call goes WAY out of the money causing the long option to be almost worthless. You can hold onto the long option until expiration to see if it moves back up a bit, giving a chance to breakeven or par your loss. You do not have to exit the long option on the expiration day of the short option. If the stock goes In-The-Money, extrinsic value is replaced by intrinsic value. If a spread goes into the money, there is a possibility of being assigned. As a general rule, if there is more than $.05 of extrinsic value on the option, you will not be assigned. IMPORTANT- being assigned does NOT increase the risk. However, being assigned does increase the amount of capital required to hold onto the spread. If there is not enough capital to hold onto the spread and the broker exits the stock assignment, then the risk increases. Whether or not your broker does this will vary from broker to broker. Do not ever be assigned an amount of stock you cannot hold onto. If this situation does occur, make sure to immediately exit the option side of the spread. If you are assigned and can hold the position, you do not necessarily need to exit that assignment because the market can then turn around, providing unlimited profit potential (limited only by how much the stock can be in your favor of the assigned position). You should be afraid of being assigned under one of two conditions- 1) If you have too many option spreads so that if you are assigned you do not have the capital in the account to hold onto the assigned position, or 2) If you are assigned a short position from being short calls and your account does not allow holding stock short. In either of these PDS Trader Manual 22

23 cases, the broker will probably exit your assignment without warning, leaving your long option position uncovered. However, there are many Debit Calendar spread opportunities that do not involve entering an at-the-money option. In/Out of-the-money entry spreads can sometimes have very low risk, really high profit potential, and, if you choose the right ones, a high probability of success. Entering In-the-Money Spreads In-the-Money debit calendar spreads are directional trades. They will only work if the market moves in the right direction. The reason for wanting to take advantage of these types of trades is Risk vs. Reward. The main 3 things to look for with In-the-Money Debit Calendar Spreads are a high Spread Ratio, low Debit, and reasonably In-the-Money (as opposed to a deep In-the-Money spread). If you enter an In-the-Money Debit Call spread, you want the market to go Down. If you enter an In-the-Money Debit Put spread, you want the market to go Up. If you are in a call spread and the market does not move down before the nearby expiration, assume that you will be assigned a short position. However, once you are assigned, you still have the ability to make money. The market has up until the expiration of the long option in order to do so. If you are in a put spread and the market does not move up before the nearby expiration, assume that you will be assigned a long position. The profit potential is unlimited after you are assigned until the expiration of the long put while the risk remains low. As a general rule, the more time there is left on the long option, the further In-the-Money we are willing to go. It is a balance between the Debit (risk), the time available, and how much the option is in the money. PDS Trader Manual 23

24 Credit Calendar Spreads Credit Calendar Spreads involve selling a far expiration and buying a near expiration. The price of the option being sold will be greater than the price of the option being purchased, creating a Credit. This "Credit" value is the maximum reward of the trade. The primary sorting method is the Spread Ratio (lowest to highest), which is the Buy Price divided by the Sell Price. This shows the relationship between the two prices, wider is better. After sorting by Spread Ratio from lowest to highest, a good Spread Ratio is anything below the 50% line, though this may vary. View the "Credit" to make sure the reward of the trade is worth the risk. Credit Spreads buy the nearby option and sell the further away option expiration, creating a Net Credit. This means you are bringing money into the account and this Credit is the maximum profit potential. After entering a Credit spread, the spread decreasing from the entry spread will result in a profit, while an increased spread results in a loss. If the spread is At-the- Money, the risk is essentially the value of the Long option. We know this because the value of the long option is all extrinsic value, and it is at the highest it can be. If the long option goes Into the Money, the extrinsic value decreases, and if it goes out of the money, the extrinsic value decreases. With a Credit spread, we are looking for more extrinsic value to decrease out of the longer term option than the shorter term option. For that to happen, generally the market needs to make some sort of move, either up or down. The first thing to know about Credit spreads is that you should never hold an Out-of-the-Money Credit spread past the expiration day of the long option. If you do not, you will be holding a naked short option and your risk will be unlimited. Of course, you can certainly still profit on these trades, but no longer have a limited risk amount. This is truer when dealing with calls than with puts, since a stock s value cannot go below zero. Best practices would be to simply exit the entire spread before the expiration of the long option. The only scenario we would consider holding onto a spread (if assigned) for more profit if it is In-the-Money is to buy a call option at around the Breakeven Level. The three things to look for in entering Credit Calendar spreads is an At-the- Money opportunity, low long value long option (this is the risk), and a big credit to long option ratio (max profit compared to max risk). In the PDS PDS Trader Manual 24

25 Trader, this means looking for a large credit and a small Buy Price. Since most opportunities will not be entered exactly At-the-Money, the max risk (buy price) is not exact, but is a good estimation. If you want to play a directional credit spread, look at Out-of-the-Money opportunities because that spread will lose value very quickly on larger market moves. It is important to note that Credit Calendar spread opportunities do not occur as frequently as Debit Calendar spreads. Additionally, Credit Spreads require significantly more margin than Debit spreads, so do not overextend yourself. Credit spreads usually do not make money if the market has not moved. If you are getting towards the end of the spread with only a few days left and not making money, remember that your risk is still limited and as long as the market makes any kind of move you will probably profit. If it does not, you can take the loss and move on. Accordingly, the best thing you can do is hold onto the position until the day of the expiration of the long option. Exit both legs sometime before the market close. If you are making money, you can exit half of the position at a 100% profit and/or wait for a one or two day move in either direction to decrease the spread value and then exit. It only takes a one day move in either direction to create a significant profit. PDS Trader Manual 25

26 Opportunities- Vertical Credit Spreads Vertical Credit Spreads involve buying a higher Strike and selling a lower Strike for the same expiration. Since the Sell Price will be higher than the Buy Price, a Credit is created. This "Credit" value is the maximum reward of the trade. The primary sorting method for this strategy-type is the "Profit Risk Percent," which shows the Max Profit compared to the Max Risk. The higher this value is, the better. Ensure that the Max Profit is worth the risk of the trade, and look for a moderate BE (Break-Even) Move. Opportune trades have a Profit Risk Percent of 75% and a 2% BE Move, though each trade is unique. For example, often times trades with a 50% Profit Risk Percent and a 1% BE Move are worthwhile trades. A vertical spread is simply a spread between two options with the same expiration date, but different strike prices. When the premium from the sell side exceeds the premium from the buy side (sell the near strike, buy the far), it is a Vertical Credit spread. With vertical spreads, whether debit or credit, the risks are 100% limited as long as the spread is exited by the expiration. Assignment of one leg potentially changes this if held after the expiration. Vertical spreads are either In-the-Money or Out-of-the-Money. Depending on the breakeven levels, whether it is a credit or a debit spread determines whether the spread is a directional trade (meaning the market has to move in a certain direction for the spread to profit), or non-directional. To make the maximum credit on a Credit Call vertical spread, the market must be at or below the lower strike on expiration. Conversely, the market closing above the higher strike will result in the maximum loss potential. In the PDS Trader, a negative BE Move (Breakeven Move) in the Credit Calls means that the trade is a directional trade. This is usually an In-the-Money opportunity. If the market stays the same when the entry BE Move is negative, the trade will lose. This type of trade has a bearish outlook. In vertical credit spreads, most directional trades happen when one or both of the options in the credit spread are In-the-Money. In Out-of-the-Money Credit Call spreads, a positive BE Move means that the market does not have to move in order to profit. In fact, it means the PDS Trader Manual 26

27 market has to move that amount in order to not profit. This means that the trade is a non-directional trade. For these opportunities, we look for a Profit Risk Percent of 100% or greater (ideally) while the BE Move is positive (the bigger, the better). Max loss occurs at the buy strike or higher for calls, or at the buy strike or lower for puts. Either way, the risk is capped. Vertical Debit Spreads Vertical Debit Spreads involve selling a higher Strike and buying a lower Strike for the same expiration. Since the Buy Price will be higher than the Sell Price, a Debit is created. This "Debit" value is the maximum risk. The primary sorting method for this strategy-type is the "Profit Risk Percent," which shows the Max Profit compared to the Max Risk. The higher this value is, the better. Ensure that the Max Profit is worth the risk of the trade, and look for a moderate BE (Break-Even) Move. Many of the principles for Vertical Credit spreads can be applied to Vertical Debit spreads. A vertical spread is simply a spread between two options with the same expiration date, but different strike prices. When the premium from the buy side exceeds the premium from the sell side (buy the near strike, sell the far), it is a Vertical Debit spread. With vertical spreads, whether debit or credit, the risks are 100% limited as long as the spread is exited by the expiration. Assignment of one leg potentially changes this if held after the expiration. There are directional debit spreads and nondirectional debit spreads. For Debit Spreads, most of the non-directional trades are going to be In-the- Money. When you find a solid vertical debit spread on the call side, look for a vertical debit spread on the put side with similar probabilities. Add a put spread onto a call spread can widen you BE Range to increase your probabilities of profit. If you enter both a call and a put spread of this type, always keep in mind that you could get assigned. In general, the risk of getting assigned is not so much in the assignment itself, but it s what could happen after the assignment. Once you are assigned, there is a potential that the market gaps. When you are assigned, you usually lose the previous risk cap, to the point of the risk no longer being limited in certain circumstances. When combining a call & put vertical debit spread at the same time, be sure to limit your trade size for margin in case of assignment. PDS Trader Manual 27