NOVEMBER 8 2021 / SUZANNE NOUKAHOUA
As the Brits like to say, when something has set their mind on fire: it’s mental; and what a lot of new traders try to do is avoid the mental math of trading because it makes them mental.
However, mental math is probably the first fork in the road between trading being a lottery game and being a consulting gig with weekly payments.
When young traders try to skip the mental math they’re always asking” “Did you use XX or did you use YY?” But actually, they used was an XYZ, and the mental math for each type of trade’s profitability would have made it clear not XX or YY, but likely XYZ.
Like Driving… If I live in Houston, and I drive to Austin it should take around 3 hours. If I got there in 30 mins it means I bought a jet, in 2 hours a Porsche, in 8 hours a train taking the scenic route, a day I’m riding a donkey. Just knowing the normal time required time to get from Houston to Austin gives you a lot of information if the time of arrival is increased or decreased. That is how the trader must grow in understanding the moving pieces of the options contract, ie the mental math of trading.
What the heck are you talking about Frau Noukahoua?! Let’s use a real example:
On the weekend a Speakeasy student mentioned using one of our morning strategies to make approximately 42K+ on Amazon that week. They expounded that they used 10 contracts, and they missed Friday’s move. So this gave everyone a bit of data for the mental math equation: 10 contracts, 4 days of potential trading, and $42K+.
So a few younger traders asked: were these put credit spreads? debit spreads? Out the money longs calls, butterflies, etc.? So it became clear we were now approaching an important moment at the Trade Speakeasy.
Could it have been put credits spreads? For 10 contracts to make $42,000 they would have needed to bring in a credit of $42.00. That would at least have been a $200 wide credit spread (in truth they’d need to be much wider). The risk on such a trade would have easily been over 150K which would have killed their buying power for the entire week. And since Amazon was down Monday and Tuesday, I”m sure they would have likely gone into cardiac arrest waiting to see if Amazon bounced off of a trendline into the positive two days later!
Could it have been any of the Condors or Butterflies, since those require 3 or 4 contacts for the structure there would be no divisible of 10 contracts, so these are likely NOT the strategy they used.
Debit spreads you ask…? Well to achieve that on 10 contracts they’d need to have had a $42.00 + cost of entry wide spread, and waited until the price went all the way through the spread and expired behind the short leg to have achieved the max profit of $42.00. However even with a $100 wide debit spread that would only have achieved an approximately .10 delta on the long and the short leg, maybe .20 on the short; even if you were closer to the money $100 on Amazon is only a .10 difference in the long and short positions. This seems highly unlikely, unless they timed it PERFECTLY on entry and exit, holding over a 4 day period? Plausible yes, likely not so much.
So out the money calls then. Well if they’d entered 10 calls on Amazon out the money they would have been cheap but they would have needed to wait until Wednesday’s price correction to get back to where they entered (after losing 3 days of theta). So Wednesday and Thursday’s bullish move would have at best price moved from a .10 to a maybe .30 delta, or from a .20 to a .40 delta, depending on how far out the money they were.
With only 10 contracts at the .10 delta to the .30 delta (not considering theta decay) $19.30 – $5.00 = $14.30 is only 14,300; or $66.40- $13.95 at the .20 delta, and with 10 contacts that would have $52,000, but it would again assume perfect timing, watching every move, and having nerves of steel.
So, the question is what did they do with 10 contracts to make over $42,000 on Amazon Monday to Thursday?