All posts by Daniel Darrow
Why Trading Options at the Open Might Be a Bad Idea
Many stock traders love the opening action because of the heightened volatility. But what’s great for stocks is not necessarily good for options — especially at the open.But trading options just after the open can be a bad idea. Options are much less liquid in the first 15-20 minutes of trading, which means less liquidity and increased risk of trade slippage. While momentum stock traders may love the open, options traders should think twice before rushing to trade.Most news headlines (like earnings announcements, upgrades/downgrades) come out after the market closes or before the open. So the first few minutes of trading is the first time prices can adjust to the news.A stock will find a new trading range based on the news, so it’s common to see things move very quickly.That’s great for momentum stock traders looking for fast moves — but those wide ranges can cause problems for options traders. Options tend to lag stocks in terms of pricing and liquidity. This makes intuitive sense because the stock’s price is an input into the options price is right. After all, you can’t have an options price without a stock price!So if that stock is attempting to digest the news and find its new trading range, then the options can’t really get right. This means that the bid-ask spreads are typically wider, and the market makers are less likely to offer the liquidity simply because the stock price less less predictable. Option books are often slower to fill out, especially on lower volume/lower liquidity contracts.And wider spreads means a higher the chance of poor trade fills. Let’s look at a weekly options chain on Zoom (ZM) after it reported earnings:This is what it looked like at the open:This screenshot was taken in the first few minutes after the open following earnings. So it’s bound to be a volatile, busy day. You can see just how wide the spreads are.Look at the $93 calls. The bid is $3.70 and the ask is $6.50 for a spread of $2.80! That’s about a 50% difference, which is a massive spread for options that should actually be trading in the $4.50 – $5.00 range.Since the spread is so wide, there’s almost no volume. There’s a massive difference between getting selling at $3.70 and $4.50. Or getting in at $5 instead of $6.50. Now let’s look at the same options chain after the first 30 minutes:Look how much the bid-ask spreads have tightened.So it’s going to be way easier to get in and out, and there’s way less slippage. That means volume and liquidity go way up.What About Stocks With No News?Now, this is a stock that had news — earnings news.On a stock with no news, there’s going to be even less options volume around the open. So it could take even longer for price discovery to happen, meaning wider spreads and more slippage. This is why I’m patient with my options traders around the open. I want to see the books fill out, and I want the spreads to tighten. Otherwise, I’m at risk of overpaying when I buy, and getting less when I sell.P.S. Want my daily options trade ideas? Click here to learn about Options in Play.
Continue Reading -->Interview With Pro Options Trader Dan Darrow
In our latest trader interview, we sat down with professional options trader Dan Darrow of Options in Play for a discussion on his unique options trading style. Tell us about yourself! I’m a professional options and equity trader based in California. I have been trading for a living since 2006, when I graduated from Fordman University. I use a “hybrid approach” and focus heavily on stocks with major news catalysts. I also use technical analysis and swing trading techniques for my options positions. I especially like to capitalize on earnings season, when we get volatile price swings. How did you first get involved with the markets? I first became interested in the markets (trading specifically) in college. Studying Finance put me on a head long path into trading. Trading fits my personality well. The markets are constantly evolving, and I love the excitement. How has your approach to options trading changed over time? When I first started trading back in 2006, I was equity only. I was focused on short-term momentum scalping, And I would get frustrated because I missed out on bigger multi-day/week moves. I began trading options a few years later to compensate for this. I focused on managing risk over longer time periods, and my strategy grew from there. And I’ve always been focused on catalyst-driven trades. When I moved to options, I adopted and improved the process How do you get over a big loss? I focus on the long-term picture. When I hit a bad stretch, I remind myself that it’s not permanent. I have 5 days a week, 20 days a month, and 12 months a year to make money. And if I come off a bad day, it’s only 17.5 hours to a potentially good day. A positive attitude goes a long way in this business. What is the one thing you wish you knew when you started as a trader? The importance of trade and money management. It’s one of the hardest things to learn, and it is critical to your success. Every trader should set parameters for their daily/monthly profit targets, trade and account stop losses, and risk-reward. Do you believe in setting specific stop loss and target prices?Do you have a certain risk management strategy for cutting losses? I absolutely believe in stop losses and targets. Like I said before, trade and money management is probably the biggest differentiating factor between a struggling trader and a successful one. When it comes to trading long options, I love the fact that your risk is the price paid. It’s almost like having risk management built into each trade. I still use stop losses, but it’s always good to know what your risk is. Are you concerned about high-frequency and algorithmic trading? They don’t concern me much when it comes to options. However, we do have to adjust our time frames a bit. Instead of only focusing on intraday and daily action, we need to look at extended rallies/drops over multiple days or weeks. What do you think about Bitcoin and other cryptocurrencies? Crypto currencies are interesting but I’m waiting for mass market applications. I’m waiting for the Microsoft (MSFT) or Apple (AAPL) of cryptos to bring them mainstream. What do you do in your free time away from trading? I love biking, music, and traveling, especially when I can do all three at once! It’s important to get away from the screens every so often to relax and recharge. If you weren’t a trader, what would you be doing with your life? Trading is all I ever wanted to do. I really haven’t thought about doing anything else since I graduated from college. I would like to open a coffee shop in a beach-side town at some point though. Many traders complain that there is too much information to deal with. How do you filter out the noise and figure out what’s important? To a certain extent, it helps to have tunnel vision. The constant headlines can make for some wild intraday moves, but since so much of my strategy revolves around earnings and events, I can really tune out the noise and just focus on the setups. What is one thing traders can do today to start getting better results? Come up with a game plan for the day and week. Not just for trade ideas, but also for P&L, targets, and stops. Think about it like a business. What do you want to accomplish today and this week? And how will you go about doing that? These are tough questions — but you have to answer them if you want to succeed. Are there any traders you look up to? I’m a sucker for the Market Wizards books by Jack Schwager, especially the original one. I read it when I first became interested in trading, and the lessons have stuck with me throughout my career. The insights from top guys like Paul Tudor Jones are amazing, and they’re as useful today as they were 30 years ago. What are your most successful “go-to” strategies? I love strangles on earnings and other events. I’m always on the hunt for “Earnings Combo trades”, which are trades that give you 2 moves for the price of 1. An earnings combo is when an event-driven move triggers a technical move. These can be real monsters and I typically use strangles on these setups. What are you most confident about in your trading? The process. I’ve done this for years and I know what works. It’s about staying disciplined, being selective, and having proper trade/money management techniques. Finally, Who Is Options in Play For? Options In Play is tailored to options traders looking for outside the box ideas. trader who is looking for outside the box ideas. As I said, I focus heavily on catalyst trades (earnings, major events). But I also like swing trades with a multi-week to multi-month time frame. Options in Play offers 2 new trade ideas per night, plus intraday
Continue Reading -->How to Trade Options Around Earnings Using Straddles and Strangles
The beauty of options trading is that you don’t always need to pick a direction — even when it comes to binary events like earnings reports. And since event-driven options trades are an important part of the Options in Play newsletter, I regularly use nondirectional strategies like strangles and straddles. The Basics of Going Long Volatility Via Strangles and Straddles Essentially, I’m looking for situations where the options are underpricing a potential move.A long strangle entails involves going long call and put options on a stock or other security. The calls and puts have identical strike price and expirations. Going long a strangle means you are long volatility, since you want higher volatility. This is because higher volatility increases the value of options.And on the flipside, a short strangle means you are short volatility, because lower volatility decreases the value of options. The straddle is a closely related strategy. A straddle is similar to a strangle, but uses different strike prices.I most commonly use these strategies during earnings season and on other binary events like Fed announcements, economic data reports, etc. So let’s go through my screening process so you can start using these strategies on your own, or at least build up your options knowledge. I’ll go through the elements one by one. Keep in mind they’re not necessarily listed in order of importance. I just want you to see how the pieces come together. Step 1: Look for Consistent Post-Earnings Stock Price Movements When looking at a company ahead of its next earnings report, I want to see some consistency in the past 2-3 reports. How much did the stock move from top to bottom in terms of overall magnitude? That’s what you want to know. The absolute size of the moves is far more important than the direction. I generally measure this in terms of points, though you could use percentages. So, we can measure the movement from the close before earnings to the range of the following day. I like to see an accelerating size of movement. If a stock typically swings 5 points on a normal day, I want to see it accelerating to 10+ after earnings. Step 2: Watch the Technical Picture This might not be the first thing that comes to mind with options, but technicals really matter with these setups. I want to see consolidations near significant levels of support and resistance. Why? Because these are price points that can really trigger the the breakouts or breakdowns, and lead to what I call the Earnings Combo move. The Earnings Combo happens when an earnings move triggers a second move — a consolidation breakout or breakdown.That’s why I’m constantly screening for consolidation gaps. For example, I look at 52-week highs or lows, or multi-year resistance or support. These types of charts are always on my radar in earnings season, and they factor into whether a trade sets up for a volatility strategy. On the opposite side, what if a stock has a huge rally or drop into earnings, or is in the middle of a long-term trend? I don’t like those setups as much because that means expectations have gotten too one-sided. Because of that, post-earnings volatility might be low because the news is priced in. So watch out for big moves or trends into earnings. Step 3: Get the Options Prices Right Of course, the options prices matter. Because after you look at the post-earnings moves from the past 2-4 quarters and examine the technical picture, you must make sure you don’t overpay for your options. How does the priced in move this quarter compare to the 2-3 quarter average move? Are the options accounting for the technical picture?Are the options accounting for any major current stock-specific or market-specific headlines? These are the types of question you have to ask. If the options prices are in-line with the recent averages, then the technical picture must be very compelling to see “Earnings Combo” potential. If the options prices are above average, then a large moving is being priced in, and going long the options may offer a poor-risk reward. But if the options prices are below average, even an average post-earnings stock move can result in a nice profit on the options. Example: Foot Locker (FL) Look at this chart of FL: The earnings reactions are in circles, and are consistently around 8.25 points. And going into the next report, the stock was in a relatively tight consolidation right at key support, with well defined gaps above and below. And here’s where things get interesting. Going into earnings, the straddle was pricing in an approximate 5-point move — even though the stock moved 8+ points in the prior reports.This indicated that getting long volatility via a long straddle made sense. Foot Locker missed on earnings, and then dropped about 9 points before closing down 8 points. And since the stock moved more than what the options priced in, the straddled paid off big!You often hear “buy low, sell high” when it comes to stocks — but the same is true for volatility. And you just saw why!
Continue Reading -->Setting Expectations for WORK’s First Earnings Report
WORK will turn in results for the first time as a public company tonight and expectations are high but price performance has been lousy. I’ll go over the numbers to watch for, technical set up and the priced in move for options. If you like what you see, be sure to follow up for more daily options strategies with the Options In Play newsletter (scroll down for more info) and the active trader education course for those looking to get started trading ==>
Continue Reading -->Why I Don’t Like Weekly Options
I have a love/hate relationship with weekly options. They are some of the most heavily traded contracts but they are often some of the worst contracts to trade. I am going to talk about when I trade them and why I avoid them pretty frequently as well.
Continue Reading -->How to Size Options Positions in a Choppy Tape
Multi-point moves each day is creating a ton of action in stocks, which means a ton of opportunities. Adjusting position size is important when the market is lacking direction like it is now.
Continue Reading -->Options In Play – Expanding on Options Collars
In this all-new video, Daniel Darrow explains how options collars work, including the benefits and drawbacks they have relative to regular hedges. He uses DE to illustrate these points more clearly.
Continue Reading -->Options In Play – Earnings on the Radar for This week
Daniel Darrow of Options in Play goes over earnings names to watch, including AYI and ISCA.
Continue Reading -->Options In Play – Closing Catalyst Trades
The type of tape is going to affect what style of earnings/catalyst trades work and also how those names behave after. Right now, we are seeing a more indecisive, volatile tape and that is impacting the exits for trade ideas.
Continue Reading -->Options In Play – Hunting for a Ramp in RH Options
There are fewer names reporting this week and even less volatile movers. RH will be one of the focus reports of the week and has a consistent history of huge swings making it a possible target for traders tomorrow.
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