# Playing Over-hot Underlyings with the Call Butterfly

A call butterfly is a fully hedged options trade …

… with an upwards bias.

It consists of four call options.

…and 2 sells.

One can play any overtly rising underlying with the call butterfly, without batting an eyelid.

Why?

Firstly, and most importantly, one is fully hedged.

Meaning?

At first look, the call butterfly seems market neutral as far as basic mathematics is concerned, that is +1, -2, +1, net net 0.

So, net net, one isn’t looking at a large loss if one is wrong.

When is one wrong here?

If the underlying doesn’t move, or if it falls, in the stipulated period, then one is wrong,…

…and one will incur a loss.

However, the loss will be relatively small, because of the call butterfly’s structural market neutrality.

And that’s magic, at least to my ears.

Method to enter anything flying off the handle with the chance of a small loss?

Will take it.

Then, also very importantly, the margin requirement is relatively less, when one uses the following chronology.

Then come the sells.

Upon the upholding of this chronology, the market regulator is lenient with one on margin requirement, as long as the trade-construct is market neutral.

Typically, for one butterfly, total margin requirement is in the range of 50 to a 100k.

Now let’s talk about what one is looking to make.

5k per single-lot trade-construct, if it’s fast, as in execute today, square-off tomorrow, or even intraday, if expiry is close.

10k if slow, as in 7 to 10 days.

If the butterfly is not yielding because the underlying is not moving, then one is looking to exit, typically with a minus of under 3k.

Just do the math. Numbers are great.

What kind of a maximum loss are we looking at, if things go badly wrong, as in if the underlying sinks?

5k to 10k.

Can the loss be more?

If the trade construct is such that the butterfly can even give 40 odd k till expiry, one could even be looking at a max loss of about 15k too.

Here’s an example of a call butterfly trade that can lose around 15-16k, but has the potential to make upto around 45k till expiry. The graphical representation is courtesy Sensibull.

I mean, it’s all still acceptable.

Tweaks?

Let’s say one is losing.

Sells will be in biggish plus.

Square-off the sells. Yeah, break the hedge.

They are losing big.

With some time to go till expiry, if the underlying goes back up, the buys gain.

What one makes off the trade is proportional to how much the underlying goes up.

It’s riskier. Correspondingly, profit potential is higher.

Money risked here will be up to double of the fully hedged version of the trade, and one could lose this amount if the underlying does not come back up appropriately and in time. Pocketed premium of the squared-off sells softens the hit.

Therefore, it makes more sense to pull this tweak with at least ten days to go before expiry, giving the underlying time to recoup.

Got another tweak.

Underlying’s on a roll, and you want to make the most possible off the opportunity.

Square-off the sells at a huge loss.

Let the buys, which are winning big, run for some part of the day.

Chances of them yielding more are very high.

If the underlying promises to close on a high, square-off the out-of-the-money buy before close of trade, and take the in-the-money buy overnight.

Risky, though.

You could lessen your risk, and increase your chances of taking most profits off the table by squaring off the in-the-money buy and taking the out-of-the-money buy overnight.

Square-off the overnight buy next morning on a high, or wherever feasible.

With this particular tweak, the trade becomes somewhat more like a lesser exposed futures transaction, at least for some time, after the hedge is broken.

There’s another thing one can do with the call butterfly.

One can adjust it as per the level of perceived bullishness.

If -1 and -1 are set at the same level, one trades for averagely perceived bullishness.

If one -1 is closer to the lower +1, and the other -1 is above this first -1, then one trades for below average perceived bullishness.

If one -1 is closer to the upper +1, and the other -1 is below this first -1, then one trades for above average perceived bullishness.

Anything else worth mentioning?

Volume. Need it.

Scaling up needs to correspond to one’s risk-profile, requirement, temperament and acumen.

One can make it an income thing by scaling up, during bull runs, or generally, just in case an up move is tending to pan out.

One can make the call butterfly do a lot of things.

It’s a very versatile trade to play a rising market, with low risk and low capital requirement.

🙂

# MP vs MoS : the lowdown on Trade-Entry

Margin of Safety (MoS)…

… hmmm…

… wasn’t that in investing?

Well – surprise – it’s in trading too.

You can enter a trade with MoS.

How?

Ok.

ID the trend.

Wait for a minor reversal.

Let the reversal continue towards a pivot, or a support or a what have you.

During this reversal, whenever you feel that you have considerable MoS, well – enter.

Why shouldn’t you wait for the pivot to get touched?

Things happen real fast at a pivot. Upon a pivot-touch, you can lose your comfort-zone even within minutes.

Two vital things can happen at a pivot.

Either there’s a quick bounce-back, or the pivot gets broken.

Pivot-break is not a worry for you.

Why?

Because you’ve placed your stop slightly below pivot, after the noise.

Upon pivot-break, you get stopped out. You take the small hit and move on to your next trade.

Eventually, things heat up.

There is movement.

Tops get taken out.

How do you enter here? (Needless to say, for shorts, everything is to be understood reversed).

Momentum play (MP)…

… is the weapon of choice.

You set up a trigger entry after a top or a resistance or a what have you, and wait for price to pierce, and for your entry to get triggered. Then you place your stop, below top or resistance or what have you.

MP vs MoS is a matter of style.

If you’re not comfortable changing your trading style to adapt to times, that’s fine too. Stick to one style.

If you’re conservative, stick to MoS.

In a frenzy, however, MoS might almost never happen.

In a frenzy, entry will be triggered exclusively through MP.

You call the shots.

# Did you invite the f-word?

… yeah…
… take it.
What?
Can’t?
Why?
Afraid of what might happen.
That’s the whole thing.
You see a setup – you trade the setup.
When you see a setup, there are no more what-ifs, supposings or anything. Then, it’s just you and the trade. Take the trade.
No room for f-(ear). It’s the new f-word.
How do you drive fear out of the equation?
Don’t allow anyone else’s negativity to creep in. Don’t talk to people. Trade on your own. No room for tips.
Don’t listen to your broker. Tell him what to do.
Once in the trade, lose the mini-bias that got you in. Now, just manage the trade.
Stop hit? You’re out.
Run?
Raise stop.
Running?
Keep raising stop.
Losing some of your notional profits? Market throws you out?
Good. That’s a proper exit.
See, fear wasn’t allowed to the party.
Look for next setup.
And so on and so forth.
Ok. Don’t trade. Till you’re up to it.

Demons out of the way?

See the next setup?

Take it.

# Does your Exit hurt you?

Good.

Good?

Yeah. Good.

A proper exit – hurts.

Huh?

What about exiting on a high?

Sure.

Who’s stopping you?

However…

… who’s to say that the high won’t become higher?

Exactly.

No one knows.

So, while the uncertainty about the high becoming higher is still out there – smarty – why are we going to not let it play out?

Exactly.

We are going to let it play out.

Purpose?

A new high might be posted. We then make more profit.

Or, trade starts going against us, and we start to lose some of what we’ve gained.

Hurt starts.

When you can’t stand this hurt anymore – exit.

That’s a proper exit.

It’s leaving a bad taste in your mouth in the end. That’s when you know it’s a proper exit.

You’ve stomped out the possibility of a new high.

You’ve taken what the trade has to give.

You’ve let the hurt set in.

You’ve let the trade arrive at its logical conclusion.

Now, you are exiting.

Congratulations, you are exiting properly.

Continue like this and you’ll become a great trader.

What, have I let the cat out of the bag?

Don’t worry, one can say it a million times and 99% of all traders will still continue to exit improperly.

It’s human nature.

Human nature works against the mindset of a winning trader.

# Winning Marketplay, Anyone?

Two words.

Psychology.

Strategy.

That’s it.

Prediction?

No.

Prediction is not pivotal here.

We’re getting psychology and strategy right.

We want winning marketplay, right?

Prediction is for losing marketplay. Prediction might be wrong. That’s when strategy and psychology save you from big loss. A big loss can wipe you out. Thus, dependence upon sheer prediction brings a wipe-out into play. That’s why, prediction is almost always relegated to the bottom rank when one talks about winning marketplay.

We’ll travel with a hint of prediction, though. Just a hint. Doesn’t suffice for losing yet.

For entry purposes. Only.

Even this hint of prediction is bias-giving, though. Once we enter, we need to quickly lose the bias. Yeah, once we enter, we only react to what we see.

Our system has an edge. It helps us choose market direction. After that, psychology and strategy take over.

Meaning, after we’ve entered, there’s no more prediction in play.

So what’s in play then?

And you.

At this point, all your mental strength comes into play.

You do have a strategy, right?

As in, if x happens, they y, and if a happens then b.

You need a stoploss too.

You don’t have to show it. It can be mental, provided you don’t fool yourself into not using it when the time comes.

Sure.

Again and again.

Till you teach yourself how to.

Till you lose big. And are still left standing. To want to enter again.

Learning to take a small hit, again and again and again – that’s winning marketplay. Requires huge psychological strength. You acquire this. You don’t have to be born with it.

Now comes another punchline.

That profit-sapling just emerging…see it? You will not nip it in the bud.

You’ll still do it.

And again.

You’ll nip it in the bud.

Again and again.

Till you teach yourself not to.

It’s not easy.

95%+ of all market players continue to nip profits in the bud all their lives.

To allow the sapling to grow into a tree is the most difficult of all market lessons. Learning to let profits run is winning market play.

To want more profits, you have to risk some of your current profits.

No more risk, no more gain.

You want to quickly exit and post that 22% gain on your Excel sheet. Sure. Why can’t you let it grow into an 82% gain? God alone knows. That’s how the cookie crumbles. You nip the opportunity to make that 82%.

What’s with 82?

Just a random number.

Am trying to get a point across. There’s a run happening. In a direction. It’s crossing +22%. Fast. Momentum could see it to +102%, to then backtrack and settle at +82%. It’s a probable scenario.

Anyways, there are some smarties that risk 12 of the 22% and stay in the trade. Soon the 22 can even go beyond 82. Lets say it does. What do you do?

Nip?

No.

Not yet.

You let it travel. Momentum is to be allowed free leeway, till it halts. Let’s say it halts at 102. You say to yourself that the winds might change if 102 goes back to 82, and tell your broker to exit if 82 is hit intraday.

That and that alone is the proper way to exit a winning trade. You exit it with the taste of loss. You let the market throw you out. For all you know, the market might be in the mood for 152. You want to give the trade that chance. Thus, a momentum target exit while the move is still on would be less lucrative for you in the long run, or so I think.

Why?

Statistics are defined by big wins. These matter. Big-time. Allow them to happen. Again and again and again.

Now add position-sizing into your strategy. The ideology of position-sizing has been discovered and fantastically developed by Dr. Van Tharp.

In a nutshell, position-sizing means that an increasing trading corpus due to winning should result in an increasing level risked. Also, correspondingly, a decreasing trading corpus due to losing should result in a decreasing level risked.

Psychological strength that comes from experiencing first-hand and digesting learning from varied market scenarios, coupled with a stoploss/profitrun position-sizing strategy – that’s a winning combination.

Wishing you happy and lucrative trading!

🙂

# Market-maker

Manipulation.

Recognition.

Alignment.

Spike.

Out.

How does one recognize manipulation?

On the charts.

After eyeballing many many charts, one gets a feel for it.

Manipulated strike-points become pivot points.

It’s a push from a fund-heavy conglomerate. Push becomes a cascade as traders join in.

After the spike, the market-maker pulls out funds so cleverly that rates don’t fall.

Funds are now ready for the next push. The same funds.

Repeat. Same loop.

Till strategy fails.

Then, maker starts manipulating in opposite direction.

Life’s busy for the maker.

There’s trouble with the authorities. Ends on a compromise. Maker will step in when authorities need to prop the market.

No maker – no market.

Why do you think there’s always a quote to your underlying?

Because of the maker.

After a market has crossed critical mass, makers sit on their spikes. They roll-over on expiries, and enjoy the ride.

Ride is not always smooth.

Makers often get greedy and break their own rules. Functioning with no safeties, many makers get wiped out. To add to their woes, a large percentage functions on borrowed money.

Makers have an electronic life, which loops from cellphone to terminal and back. It’s a life that’s punctuated by headaches, physical and mental.

Don’t envy a maker.

He or she is just doing his or her job. That’s all.

# What’s it Gonna Take Today, Pal?

Indicators.

Fibonacci.

Moving averages.

Price action.

Isn’t everyone following all this?

Do the markets behave accordingly?

No. Not really. Sometimes, sure. Generally, no. Just my opinion.

So?

Where does that leave you?

There’s not much planning to it really.

Oh yeah?

Pray on what basis is one to enter then?

Study.

Then overall feel.

What?

Yes.

Gumption?

So?

With no study, direction’s a 50:50.

With study leading to overall feel translating into gumption, this ratio could well become 55:45.

You don’t need more.

Blackjack odds for the card-counter are perhaps 53:47 at peak.

Ok, so you’ve got your 55:45, what then?

Formula?

Simple one.

You cut the wrong call. Nip it in the bud.

Let the right call continue being even more right.

Learn, perhaps the hard way, to let the winner continue winning.

That’s the risk you have to take, to win more.

There are no free lunches in life.

# Can I Really Really Really Do Without Fundamentals?

I like to trade without a bias.

Lack of bias means freedom…

… freedom to think independently…

… not falling prey to another person’s opinion…

… which then allows you to listen to your system…

…setup demarcation…

…trigger-entry…

… trigger-exit…

… exited.

That’s it, move on to the next trade.

News gives me a bias.

No news.

You know what else gives me a bias?

Fundamentals.

I don’t wish to look at fundamentals.

If my eyes are seeing a setup in the EuroDollar, I would like to take it without the nagging thought of “what will happen if Scotland says NO or YES”.

I don’t want to care about inflation numbers, or job figures, or industrial output or what have you.

I mean…can I just …do it?

Meaning, can I just do away with fundamentals, and focus on technicals only, which is my area of specialization?

Sometimes, I get a little unsure.

I start looking around.

How are others doing it? The experts, that is.

My uncertainty gets fanned a little more, when I see experts not really ignoring fundamentals, even though they might be specialized in technicals. Hmmmm. I’m still not happy looking into fundamentals. I mean, why should I take time-out from my strong suit, and devote it to my very weak suit?

No, I decide. I’m really not going to look at fundamentals.

What’s the worst that could happen?

Let me just see if the worst that could happen is bearable.

Ok…I ID a trade…demarcate a setup…and the trade goes against me because of the announcement of some number in the afternoon. People looking at fundamentals would have waited for the announcement of the number and then traded. Fine.

In the world of trading, it is always good to have the worst-case scenario unwrapped and right before your eyes to see what it really means.

You know, I can take this.

Would you like to know why?

Firstly, I would like you to understand that we are looking at large sample-sizes here. Any sensible reasoning would only apply to large sample-sizes.

Over the long run, and over many, many trades, Mrs.Market will go either way after an announcement of a fundamental number with a chance of roughly 50:50.

If this is true, it is very good news for me, good enough to just kick fundamentals out of the equation.

At times, the market reacts as per the crowd’s anticipation.

At other times, it reacts in the opposite fashion.

I assume that the ratio of the above two directions taken by Mrs. Market over a very large sample-size would be 50:50.

I think my assumption is correct. I don’t want to go through the labour of proving it mathematically.

Ok, let’s assume that my assumption is correct. I then kick fundamentals, and go about my work while relying on my strong-suit, i.e. technicals. This trajectory will very probably have a happy ending.

Now let’s assume that my assumption is wrong.

What saves my day?

Technicals.

Technicals very often give setups that factor in crowd behaviour and crowd anticipation of market direction.

Technical setups get one into the build-up to an announcement.

More often than not, one is already in the trade, in the correct direction, enjoying the build-up to an announcement without even knowing that the announcement is coming, if one is not following fundamentals.

Technicals can actually do this for you. I’ve seen them do it. I mean, the GBPUSD has been giving short setups during the entire 1000 pip run-down recently. To have availed such a setup, people haven’t needed to know that a referendum is coming. All they’ve needed to do is to take the trade once they see the setup.

Actually, that’s it. I don’t need more.

I don’t need to reason anymore with myself. Everything is here.

I think I can let go of fundamentals safely.

Even this trajectory should have a happy ending.

# Dealing with Noise…the Old-Fashioned Way

There’s a sure-shot way to deal with noise…

Yeah, the best ideas in the world are – simple.

Let’s not complicate things, ok?

So, what kinda noise are we talking about here?

We’re not talking about audio, you got that right…!

The concept is related, though.

If you’re charting, you’ve dealt with noise.

Yeah, we’re talking about minute to minute, hour to hour or day to day fluctuations in a chart of any underlying.

Markets fluctuate.

While discussing noise, we are pointing towards relatively small fluctuations which generally don’t affect the long-term trend.

However, noise has the capability of deceiving our minds into believing that the long-term trend is turning, or is over.

Don’t let noise fool you.

When has the long-term trend changed?

When the chart proves it to you through pre-defined fashion. That’s it. You don’t let noise to get you to believe that the long-term trend has changed, or is changing. Ever.

Moving averages crossing over? Support broken? Resistance pierced? Trend-line shattered? ADX below 15? Fine, fine, FINE.

Take your pick. You have many avenues giving decent signals that the long-term trend has changed or is changing.

How about eyeballing? Works for some. Like I said, let’s keep this simple.

So let’s get noise out of the way.

Random numbers generate trends – you knew that, right?

You don’t need more.

Once you’ve identified a trend, that’s your cue to latch on to it.

We’re not talking about predicting here. We don’t need to predict. We just need to identify a trend, and latch on. That’s all. No predictions. Not required.

From this point on, two things can happen.

Further random numbers deepen the trend you’ve latched on to. You make money. Good.

Or, the next set of random numbers make your trade go against you, and your stop gets hit.

If your stop is getting hit, please let it get hit. Even that qualifies as a good trade.

What you’re not doing is letting noise throw you out of the trade by deceiving your mind.

So, here’s what you do.

Till when?

Don’t look at your trade till you’ve decided not to look at it. For the day-trader, this could be a couple of hours. For the positional trader, it could be days, or weeks.

By not looking, you won’t let noise deceive you.

If the trend doesn’t deepen, or goes against you, you lose the risked small amount.

Just remember one thing.

A loss has immense informational value. It teaches you about market behaviour patterns. It also highlights your trading errors. Many times, losses occur without any mistakes made by you.

Ultimately, if the trend deepens, you’ll have made good money, and can then further manage your trade after the stipulated period of not looking.

This is the sweet spot.

This is where you want to be, again, and again and again.

Sitting on a large profit gives you room to play for more profit by lifting your stop and your target simultaneously.

To reach this sweet spot again, and again and again, you have to position yourself out there and appropriately, again, and again and again.

This is also the nature of trading.

Wishing you happy and lucrative trading!

🙂

# Charting Charting Charting

Why don’t you just…

Not the level.

Not the expectancy of a turnaround.

And, although I still do this because it gives me a kick, why do we even trade corrections?

Why can’t we just trade the sheer chart?

Every chart is either going up, down or nowhere.

So it’s pretty obvio, that the first step would be to…

… to what?

… to decide where the chart is going.

Again, it should be pretty obvio, that if a chart is going nowhere, then you are doing… what?

Are you trading such a chart?

NO!

Wait for such a chart to break out in one particular direction.

Wait for the LTT to turn in this direction.

Then trade this chart. Not before.

Yeah, LTT stands for long-term trend.

Yeah, we’ve befriended the LTT so much, that we have an abbreviation going for it…

Once you’ve sorted out the direction, look for an entry setup.

Be patient.

If the entry setup hasn’t formed yet, wait for it. If you can’t stop your twiddling fingers from doing something, feed in a trigger entry in case of a hypothetical setup formation within the next few hours / days, if your trading station allows this.

There’s no up or down anymore, to be honest. You are going where the chart is going, period.

You are also not asking the stooopidest question of them all…

… you guessed it… “Did the sensory index go up, or down?”

Just forget about the sensory index, ok?

I mean, we’re so done with sensory indices in this space.

Why?

DLF could tank 20 bucks on a day the Sensex goes up. Dow Jones could be down 50 points, but Pfizer could just spring into a stellar upwards move. Why should we have lost the short-side opportunity that DLF hypothetically gave, or the long-side opportunity that Pfizer could present, for example? We will do exactly that, i.e. lose the opportunity, if our focus is on the sensory index.

Focus on the underlying.

To be more precise, focus on the chart of the underlying.

🙂

# So…What Does Trade Selection Hang Upon?

Feeling.

Feeling first, feeling last.

Math in the middle.

That’s my recipe for trade selection.

For me, trading is an art.

I rely a lot on gut.

Many people tell me that’s wrong.

Everyone’s got a right to their opinion.

What works for Jill might not work for Jack.

People tell me to get emotion out of the way.

Emotion can be an ally too.

Just try and get the hang of your gut feel.

Let the trade speak out to you.

You’re looking at a chart, and the chart should shout out to you – “Trade me!!”

That’s what I call “Feeling First”.

I mean, whoever made that proverb about first impressions sure knew what he or she was talking about.

So, after your first impression tells you that a chart is tradeable, you then need to see some kind of a mathematical fit going for you.

You try and fit some mathematical model into the underlying’s previous behaviour, and plan the trade into the near future based upon the future-play which your model spits out.

You calculate a stop according to your money-management rules. Just more math.

Now comes “Feeling Last”. You look at your chart, which contains the entire map of your trade.

At this stage, your gut must speak to you.

Yes or no.

Nothing else.

Are you pulling the trigger or are you not pulling the trigger.

If not, then no whys. It’s a no. Learn to take a no. Look for another trade setup, elsewhere.

If yes, then again – no more whys. It’s a go-ahead. Have the guts to follow through.

Keep it simple.

The best ideas in the world are – simple.

# Options Setup El Cheapo

What are the basic ingredients of a cheap options setup?

We’re not bothered about what the underlying is.

We’re outlining in general.

A correction / rally needs to have taken place.

The correction / rally level needs to be significant.

That’ll account for the cheapness of the option.

I suppose it’s obvio, but I’m still saying it nevertheless, that you’re going to be trading in the counter-correction or counter-rally direction, but in tandem with the overall long-term trend.

Then, a slight move needs to have started in your trade direction after this significant correction / rally.

That could account for correct choice of trade direction.

We need just one more ingredient.

Can you guess what that is?

Yeah, breathing space.

Buy an option which has at least 3-4 weeks left till expiry, if not more.

That’s it.

It’s as simple as that.

Lucrative ideas are simple. There is nothing complicated about them.

Lose your sophistication and / or complicatedness. You’re not going to make it big by being sophisticated or complicated. These two characteristics will negatively affect your trading. Flush them down the drain.

Be simple.

🙂

# We Like to Move it Move it

We do our home-work.

We know our risk-profile.

Our systems are in place.

We know the exact market-segments we are tapping into, and those we are leaving alone.

Our fund-allocation profile is at the back of our palms. We know where what is, and when. We know how to move it.

In our identified segment of activity, we have a feel for the underlying. We can sense it. We don’t need to preempt the underlying, but we can if we want to.

We are not afraid of small loss. It can happen again, and again, and again, as far as we are concerned.

We use stops. Definition of risk is our abc.

We try not to follow news. It gives us a bias. We trade the setup we are observing on the chart of the underlying. Everything else is “egal”, as they say in German, as far as the trade is concerned. We are not going to be biased while trading. We are going to take the setup, in whichever direction it presents itself.

We are nice to our families. We gel with them, and have enough time for them. We are happy in their company. They are not a distraction to our work, but a welcome change. We’ve got a substantial-sized emergency fund going for them, which more than takes care of their needs. This fund generates regular incomes for our families, and we don’t touch the emergency fund, come what may. We might keep adding to it, though.

We take high risks with a very small size of our networths, everyday. Our risks are calculated, and can generate high returns. They can also result in total losses. We practise sound money-management, and put ourselves in line for big profits, again, and again and again.

Yeah, we like to move it move it …

… from one trade setup to another, to another, to yet another, an so on and so forth.