Tim Bourquin: Hello everybody and welcome back to TraderInterviews.com. Thanks for joining me for another show this week. We're going to be speaking with full-time option trader Steven Place. He has a website,
InvestingWithOptions.com that is very popular. I wanted to get his take on how he trades options, how he looks at the markets so that we could all learn something from that. So, Steven thanks very much for joining me on the phone today.
Steven Place: Thanks for having me.
Tim Bourquin: All right. So, maybe describe for our listeners your overall philosophy of trading the markets. Are you a day trader or a swing trader? What do you do?
Steven Place: I'm generally a swing trader, but I will end up with day trades sometimes. I primarily trade options on domestic equities. And my overall philosophy is there is always going to be risk of being mispriced whether it be to the downside or the upside. And we can see the perception of risk quantified in options. And if that's being misperceived then there's an options trade available to take advantage of that.
Tim Bourquin: All right, great. I'm glad you brought that up. So this leads to then the obvious question what does that mispricing look like to you either on the stock chart, in an options chain. How do you find it?
Steven Place: Okay. You have a couple of extra dimensions when you're playing options. When you're playing stock, if you're just trading straight equities or equity futures or something like that, you only care about the direction, okay, whether it's going to go up or down. In options you have two extra dimensions. You have not only the up or down, you also care about how fast and how long, okay. So, you can be right on a play but still lose money because your perceptions of volatility, risk, and time were wrong, okay. So, with those three dimensions you have one extra measure of supply and demand. So, you have supply and demand in stock, okay, in the direction you can see that represented in a chart. But to see the supply and demand for risk, you look at the options premium and that's - you know it's like an insurance market. People are willing to pay a higher premium for a way to protect themselves if they feel that the perceived risk is much higher, okay. So if you're paying for hurricane insurance in Oklahoma, you're not going to be paying a high premium because the risk of a hurricane is very low. But if you're on the Gulf Coast, the premiums are going to be much higher because the perceived risk is much higher.
Tim Bourquin: So, the more likely the event is to happen, i.e., the stock to hit that price, the more you're going to pay for it?
Steven Place: Yes. And sometimes the risk market, the options market will be overpricing a significant risky move or it would be underpricing a risky move, and this remember is both to the upside and downside.
Tim Bourquin: All right. So, how do I know then that that's happening? Nobody knows where the direction of the stock is going to be obviously. So, how do you know that it's overpriced or underpriced?
Steven Place: You'll see it sometimes. You can measure it through - let's say you trade the S&P and we normally look at - if you want to measure the S&P premiums, you look at the implied volatility across a certain set of options. And we generally see that in the VIX, okay. Now, volatility, the supply and demand for protection against risk, the supply and demand of premium behaves a little bit differently than the supply and demand of stock. Stocks generally tend to trend and have momentum, okay. Volatility generally doesn't do that. Volatility will mean revert much more often. The supply and demand for premium will mean revert much more often than stocks, okay. So, you can have a thesis on the direction of the stock, but you need to define your thesis on if it's going to move very, very fast or if it's going to have a slow crawl. And you can look at that by measuring - well first off you can look at the overall perception of risk using the VIX or other measures, and you can also look at the options premium being had for that particular underlying name.
Tim Bourquin: So, I can look at the premium and I can say because it hasn't - let's say the VIX hasn't reverted to the mean and the S&P you think is ready to do that? You could somehow buy the option on that to take advantage of that?
Steven Place: Yes. If let's say that the market did its thing and it you know pulled back significantly and then the people said, "Well holy crap I need to go out and buy puts to protect myself." Odds are they're overestimating the risk in the future because they are overreacting to the current price action, the price action that just happened. So if you see a sharp drop in S&P, and then the VIX spikes there are ways to sell volatility and maybe get a little bit slightly bullish via selling premium. You can become the insurance salesman because people are overpricing risk. You can do the same thing as well when people are underpricing risk. You know if we go back to April of 2009, we just had this slow crawl to the upside. Risk was being essentially underpriced. We saw the VIX down into the teens and that was a good time to start saying, "Okay it's time to start looking for protection." You know all my shows I was advocating buying protection or converting to a place that locked in your downside risk because there may have been a volatility event on the horizon. And I got lucky on that one because then we had the flash crash and everything like that.
Tim Bourquin: So were you actually long puts during the flash crash time?
Steven Place: I was. It was a little interesting for me because I was in a lot of cash. I had some iron condors where I'd bet on a range and I was essentially waiting. And I did buy some put spreads and everything like that, but I didn't really go for directional trade on the S&P. I would have rather waited for the volatility to come in. So we had that high volatility environment then we've got that slow crawl up to about 117 or so. And I started to sell call spreads which you know volatility was rather high so I was bearish on volatility but also bearish on equities, okay. So, that's how I played that on the second leg lower down to 104.
Tim Bourquin: And I think you mentioned doing spreads and iron condors. I see a lot of newer traders that are just playing one side of it, not hedging it. But most of the successful option traders I talk to are almost always strangling or straddling their plays. They're rarely going long a call or selling a put without hedging it some way.
Steven Place: Now, if you're option buying, straight options - you know buying calls and buying puts, odds are you have a smaller account and you're just looking to leverage off. Okay so all it is, is leverage stock pick which is fine if you're good at it. You know if you are in the market for a short amount of time and you're just looking to play for a strong move that's fine. However, what if premiums fall okay or what if the stock doesn't move as fast and you know the premium comes out due to time decay? There are some significant disadvantages with that and there are ways - you know sometimes buying straight calls and puts or selling straight puts makes sense. But other times there are better ways to structure your risk where you can take advantage of the idea that you have of where the market is going to go but still you know limit your downside risk.
Tim Bourquin: I think that it seems that a lot of traders - I mean I know when I first started trading and dabbling in options, the thought of hedging a position was good, but then you know you always feel like I'm paying some insurance to make that happen. And I guess the greed in me was always like, well if I think it's going to go in this direction, why am I hedging it? Let's just make as much money as we can. And I think that's probably why I didn't do well.
Steven Place: Well that's what I look to take advantage of in the market. Because people kept - like in April people kept saying that the market the overall trend is up. I can just use stops and use trailing stops and get stopped out. And then we had the flash crash where there was significant structural damage to the market. And now people are saying, well I need to go out and buy puts because my stop losses might not be working because of the structural damage. So, it swung from one extreme to the other in the course of about a month.
Tim Bourquin: A lot of traders who trade options who were successful at it have no idea why anybody trades individual stocks. I mean did you come at this initially because it was cheaper to play? Your thought is this way?
Steven Place: You know, I did like to level up, but I did more advanced strategies where I did hedge and things of that nature - you know focusing on calendars and spreads like that. You know, I still do some directional plays, but you know this market right now is really choppy so it doesn't make a whole lot of sense to just be buying straight calls and puts especially at the premiums that are being offered.
Tim Bourquin: You've talked about the overall market and the index, S&P. What about your individual stocks that you're trading for domestic stocks? Talk about how you find good opportunities with individual stocks.
Steven Place: You know I definitely look for technical screens. There are a couple - they're my bread and butter. And the problem with trading options is that you know you have the giant universe of stocks, but there is a much smaller bucket of liquid options, okay. And liquidity is a huge deal when you're trading options because if you try and exit the trade and the bid-ask is 50 cents wide, you're going to get significant slippage and it's going to really eat into your profit. So, you now I focus on a lot of the liquid names, you know the Apples, the Potash, the RIMs, the OIH. But sometimes there are technical setups are that going through that you know it may not be that liquid, but I still think that the overall direction is worth the potential slippage that I do have in the name.
Tim Bourquin: Talk about some of those technical setups that you like. Are they specific patterns that you're watching for?
Steven Place: Yes. You know I like - if momentum is working, breakout patterns generally will work. You know if I'm looking for something that's already broken out, I call it the PBTBO. It's the pull back to break out pattern where previous resistance becomes support. I also use moving averages just as a general area. If you get a stock that is trending very, very well and then we get a little shake and bake back to you know the 20-day moving average, I'd be looking to sell puts spreads on the assumption that the trend is not broken and it's not going to go down as fast the options are pricing it. That's a pretty good technical setup. I also do some earnings plays and play off certain price levels as well.
Tim Bourquin: Okay. Talk a little bit more about the first one you mentioned, the PTTBO I think it was you said.
Steven Place: It's just an initialism. It's pull back to break out. You know if you have a very key level of resistance on the daily chart, if the stop break is above it and it does show on good volume sometimes, not always, it will come back to retouch that level to see if the market structure and that there were actual buyers at that level. And previous resistance will become support most of the time okay. That is a pretty good expectancy. And you can find some buying plays right there at that support level.
Tim Bourquin: Can you talk about maybe a recent trade that you've had either this week or last week, maybe even a few weeks that you're particularly proud of that you did well. And what got you into and what got you out of it; kind of from start to finish?
Steven Place: All right. Well I've been on vacation so...
Tim Bourquin: Okay.
Steven Place: ...you know, my trading has been light. One of the good trades and this was a bit of a nice catching trade. This one didn't have that good of an expectancy in general, but I did play OIH to the long side, okay. Now, this is one where you also have to look at not only the direction of the stock but the implied premiums, okay, the implied volatility. I felt you know there's all the voodoo going on with BP and Diamond Offshore and pretty much all the oil services. We saw strong breakdown and we saw a lot of really nasty volatility coming in. Well, along with that downside move there was a huge spike up in premiums, in OIH puts because investors are saying well holy crap I need to buy some puts to protect myself or you had the speculators coming in and say, well I'm looking for a very, very strong move to the downside and I want to buy puts.
So I said, okay I'm going to be the AFLAC for trading. I'm going to sell insurance to these people. Now, to do that, you sell premiums and you could sell puts just completely naked but that leaves you with a limited downside, okay. That's not necessarily the best thing. So, what you can do is do a bull put spread where you sell puts and then you buy puts that are a little bit more out of the money, a little further out of the money, and that way your risk is limited to the difference between the strike prices of those two put contracts, okay, less the credit you receive.
So, we did I think it was the July - okay this was about a month ago. We did the July 8410 and 8910 bull put spread and it's a funny strike price because it's an ex-dividends options thing, okay. It's just a nuance of the market. But the difference between the two strikes was 89 and 84 so five bucks. So you're risking $500 less the credit you receive and I think we received the credit of I think it was $1.20 or $1.10. So we were risking about four to make 1 okay. And you would say, well why would you do that? It's because break even at July expiration would be 89, okay? So as long as OIH stayed above 89 we would be profitable. We just exited out of this trade on the gap up on Monday. We bought it back for 20 cents. So we made 80 to 90 cents profit on that particular trade, okay. So you know a lot of people have been trying to catch the knife on the oil names, it hasn't been working. But that's been one of the better ways to structure your risk in that sort of volatile environment.
Tim Bourquin: How long did it take you to get comfortable with the credits and how much money and the risk? I always find when I was doing options - I didn't do a lot now - but it was easier for me when I could see graphically what my maximum risk was, what my maximum profit was. Do you still kind of draw that out or are you just know it in your head now and you're able to calculate that pretty quickly?
Steven Place: Actually, I use thinkorswim as a brokerage and they have a pretty good risk profile monitor so... You know it's very easy to graphically represent the sort of risk you're taking with spreads now. I can do it in my head really quick. You know you just look at the difference, you add the credit and your break even is you know the short strike plus the credit and everything like that. It's the same thing with iron condors and calendars and everything. It does get very intuitive especially when you're looking for particular plays in and out every day. It's one of those things that you just start calculating in your head very quickly.
Tim Bourquin: That's part of me being a political science major rather than a math major. I guess I just need to see on a graph sometimes even when it's simple.
Steven Place: Oh, me too. You know I'm not going to sell I'm not going to put a trade on unless I can actually see it.
Tim Bourquin: With that oil play for instance, how did you know at what point you were going to take it off when you saw that gap? What was it that said it's time to get out?
Steven Place: It comes down to risk and reward. There was 20 cents there was $20 left of premium for an option trade that had you know three weeks to expire. So, there is still risk of further downside and then you don't get that better feel. So, it's just one of those intuitive things, you know. If you have a put sold and there is 10 cents left in the contract and you've got four months or four weeks, you're going to take it off and there's you know could probably quantify it into a system where saying if I've gotten 50% of the credit within a week, I'm going to take it off and then I can reenter if I want to. And there are rules that you can define. It's more intuitive for me to be honest with you.
Tim Bourquin: Okay. And there's always that gut portion of trading.
Steven Place: Yeah.
Tim Bourquin: How much of your trading would you feel is part of that kind of gut, intuition kind of feel for the market?
Steven Place: More than I'd like to say. There are certain names that if you know they're not nice catching names but there are names that I know that I just have a feel for the price action, the premium. OIH is one that I generally have a good feel on. Potash is another one where I feel, you know I can generally see when premiums are getting a little hot with respect to how far it's going to go down, and that's just the current market structure potash has been ranged down for the past year or so. So we have those and then you know there are other setups with respect to earnings trade that are a little bit more systematic. There are hedges that are a little bit more systematic and everything like that.
Tim Bourquin: How about like an FOMC announcement like we had today. Is that something you'll do options on, on the broad market?
Steven Place: No. You know especially today it was just a lot of chop. Anyways what we did today on the FOMC announcement is we actually sold iron condors strictly because the VIX got back up to levels that you know I felt were a sale. So, that was a good way just to get short a little bit of volatility. And that's just one of my thesis that the market could be ranged and I'm going into these options expiration. You know if you're trading options short term, day trading options, it becomes very difficult to do that especially if you're trading in the liquid names but not only that, you have to ask yourself why are you trading those options on the very short term. You know, you have Option Greeks, you have delta, gamma, theta, vega, rho and a couple others okay. When you're day trading all you're looking to do is take out the most amount of delta, the stock price movements in the shortest amount of time and options are not necessarily the best vehicle to be doing that. You should probably because that's pretty much just leveraged stock, I think you should go out and get a margined account and trade stock because there's more liquidity there.
Tim Bourquin: Well when you look at an options chain, the question you probably get a lot is I've got all these expirations, how do I know within the chain itself which options offer the best opportunity? Are they all typically overpriced or underpriced or do you find others that are particularly sweetly overpriced or underpriced to use?
Steven Place: You have a couple of risks and you can analyze this using an Excel spreadsheet. You have your delta risk and your gamma risk, okay. The delta risk is the amount of shares that you have effectively long or short. So if you're looking at an at-the-money call in something generally it's going to have a delta of around 0.050 or 50. That's means you're going to be - if you buy that call, you're going to be effectively long 50 shares of the underline. That's just one of those things. Now, you also look at the premiums being paid. If you have an at-the-money option that means that's just one strike out of the money. That's means the entire value of that option is premium, okay. So you can actually look at the ratio of your stock exposure relative to the premium you pay, okay. And that generally gives you the sweetness factor. And what I've found is that you know more than - if you're selling options, if you're selling puts or put spreads, generally no more than one strike out of the money is you know the delta risk and the premium is worth it all right? Just because the further at-the-money you're going to be the higher the premiums but the more delta risk you have. But if you go very, very out-of the-money, it's going to have very, very little premium and then you get into gamma risk. That's the acceleration of the option. That's the heartburn, that's the part the sucks if you're short, but it's awesome if you're long, okay.
Tim Bourquin: I think a lot of traders they just see those cheap options and they're so tempting because you can get so much on at such a low price, but obviously there's still risk involved.
Steven Place: It comes back to risk, reward, and premium. Do you think that the premiums offered are worth the risk of assuming, okay and that's when you're shorting options. And if you're long options, do I think that you know if you're buying calls do I think that the upside risk is worth the premiums? Do I think that stock is going to move fast enough to justify me buying in right here, okay? If you don't then you need to do a spread or you need to do something that's bearish on volatility.
Tim Bourquin: Right. And the stock inevitably never seems to move fast enough or hard enough to make it move like you think it should in the underlying option or in the option itself? You know that's got to be part of your gut feel I guess.
Steven Place: Two-thirds of the time that's right, okay. So, if you think you're a genius and you just say, we'll I'm just going to go short options because the stock never moves as fast as what the options are pricing in, you're going to be right two out of there or four out of five times. But that one time will erase all your gains from the other times you're shorting those options, okay. And we saw that you know most recently the flash crash and it's pullback to the February levels will stocks move to the downside as fast as what options are pricing in? Well if you go back over the past nine months, generally no but this one time it did and it pretty much wiped out any gains you may have had from that level if you haven't been managing your risk appropriately.
Tim Bourquin: All right good point. And that is I'm sure common to a lot of traders and it's probably you've been successful at this is because you've kind of been through all of those issues. I'm sure you did that at some point and you decided, okay this is not really the right way to approach it. Was there kind of one thing that you did in your trading career or in your education that you learned that kind of took your trading to the next level with options?
Steven Place: We had 2008 and if you were an option trader and you were a net option buyer to the downside it was a very, very fun time. If you're long stocks, it wasn't that fun right? And then we had 2009 come along and we still had some volatility and then it just slowed to a crawl relative to what we saw in 2008 and momentum based strategies especially to the downside didn't work as well as the mean reverting strategies and volatility selling strategies, okay. And so what that has told me is that there's a time and place for everything. There's a time to be buying volatility and time to be selling volatility, and that generally comes in cycles. And to be a successful options trader you not only have to recognize the direction of the trend of the stock market, you also have to recognize the trend as well as the turning points in the risk market.
Tim Bourquin: Do you set goals for yourself in terms of the dollar amount you want to make trading for a living?
Steven Place: I'm looking for about 3% a month. It's generally my idea. And that's fairly conservative, but that's what I'm looking to get with respect to options selling. You know you can have more speculative strategies in there and you can be much more aggressive on the short term if you're trading Forex or futures, and you know I've been leaning towards that side because you know I like my reward. But if you want to take less risk and you want to be more conservative, that's generally the area you should shoot for.
Tim Bourquin: Where have your most successful option trades been this year either long, short, on the general S&P, individual stocks. Where have they been?
Steven Place: I can tell you what my least successful has been. And it's been in trading iron condors on the big index options, the Russell, the SPX and not IWM or SPY; those are sort of the cash set of the stock settled mini indices, right? You know, it's one of those where I had too much negative gamma on and I got shook back and forth on both of them. And so those have been very, very frustrating and what I've learned from that is not to trade the big options, just to cut back in size and slowly leg in, and that's actually been more successful for me this past month. In terms of strategies that worked for 2009, put selling and put vertical selling have been sort of my weapon of choice. You know buying into a lot of these pullbacks, especially when we saw big, VIX spikes and big premium spikes has been working very well.
Tim Bourquin: So you're talking about 2010, this year or are you talking about last year? You said 2009, just wanted to clarify.
Steven Place: Yeah, I'm sorry. Second half of 2009 to first half of 2010.
Tim Bourquin: Got it okay.
Steven Place: Whether those strategies are going to work in 2010 remains to be seen because you know we have a different risk environment there. The correlations in global assets have increased once again. We're back on the big liquidity conveyor belt as I like to call it so we don't know if those strategies and techniques are going to continue to work going forward.
Tim Bourquin: All right as we finish up here then, how do you keep yourself flexible? How do you kind of just go with the flow if you will everyday when you get up in the market? That's hard for a lot of traders to do, to change strategy, to change viewpoint.
Steven Place: That's the hardest question you've asked me. Where exactly do you say okay it's time to cut this particular strategy and move on. You know obviously if something isn't working in your trading, you need to say okay is it systematic or is it part of my discretionary nature? Do I need to change my mindset or do I need to change my system? So far my system is doing fine. And you know since my vacation, I haven't sold any puts yet. I've done a couple of spreads and everything. I'm keeping my trading a little light until I get the feel of the market once again. But there are some key technical levels that I'm watching in terms of stock market structure that I'm watching to say okay it might be time to start changing strategies. And generally you can see the key levels, you can draw it with the crayon on you know the spiders or you know if you look at the XLF or anything like that. So I'm watching those and if those start to break especially to the downside, I'm going to be changing my strategies significantly and I'll going more into the 2008 mode. The 2008 kind of trades buying puts on breakdowns haven't been working at all. So if we start to see those trades start to work again, then I'll start shifting my strategies.
Tim Bourquin: All right final question. What do you like about trading? What is it about the trading and the lifestyle itself that appeals to you personally?
Steven Place: I consider myself pretty smart. But smart people are terrible at the stock market because smart people didn't have to work that hard in school and you know there's not a huge challenge. This has been the hardest thing I've ever done in my entire life and I like that. I enjoy the challenge. I enjoy the competition. You know I was at the traders' expo and it was great to meet all these people, but then again I was thinking I just want to take their money. It's one of those things you know. It's the competitive spirit and that sounds terrible, but if you think that that isn't the case, then you shouldn't be trading. People are out there to take your money and I think I can do better than them. It's the highest competitive environment that you can ever get into.
Tim Bourquin: What do you think you can do better? Where do you see areas where you need to improve as a trader still?
Steven Place: I need to find - because a lot of my stuff like I said it's a lot of discretionary stuff. I'm looking for ways to quantify my strategies a little bit better. You know, I do have these feels in terms of extremes and the overall psychology of the market, but sometimes it's nice to have sort of a system in place. On top of that I'm looking to expand strategies outside. Because you know if we pull a 1997 - you know I don't think it's going to happen, but if we pull some sort of low volatility climb environment where you know, nothing's moving, I don't think that's going to happen this year but I definitely need to start looking at other asset classes to trade, whether it be you know Forex, fixed income and everything of that nature. And in terms of strategy development, it's just one of those things where I'm trying to constantly improve with respect to position sizing and stops and the option strategies that are working right now.
Tim Bourquin: All right. Well, Steven Place can be found at InvestingwithOptions.com. You can find him on StockTwits as well. He does some great stuff for StockTwits TV that he links to on his blog as well so you can check them out there. Steven thanks for your time. I really appreciate you talking about options today with us.
Steven Place: My pleasure.
