Understanding Risk

I had a very good conversation with a reader recently. He is getting started in trading options and was looking for ideas with the S&P 500 (SPX/SPY). As that’s what I do almost exclusively, I was glad to hear his ideas and give my opinions on them. But the conversation really turned into a discussion about risk. He, as well as many newer traders, want to find ways to “play it safe” and minimize risk while still making money. Of course, it’s not just newer traders who want this. I think everyone would be happy with a low-risk strategy that makes money. The reality is that this business is a risk management business. We, as options traders, are paid to take on risk. That doesn’t mean we should take bad risks chasing high rewards, but we can’t entirely avoid risk either. But, more importantly, I think it’s important to understand the risks of a position or strategy. There are lots of different options plays out there each with different risk profiles. In addition to the contracts that make up the strategy is the element of time. And it’s easy to get drawn into a strategy that looks safer than it is. That’s not to say it is a bad strategy. There are times when most strategies are good plays. But it’s important to know the real-world risks of a strategy before deploying a significant amount of capital on it.

The Risks of Options

So, before talking about the risks of the trades he proposed, I think it’s worth talking about the risks of an options trade. One cannot define the risks of a trade without knowing the actual risks.

  • Price risk is the one risk that most people understand as it’s similar to the stock world. The price of the underlying defines the intrinsic value of a contract. A contact that is in the money (ITM) has inherent value as opposed to an out the money (OTM) contract. Long calls and short puts benefit from a rising price in the underlying while Long puts and short calls benefit from a falling price in the underlying. These risks are estimated in the greeks delta and gamma.
  • Time risk simply refers to the amount of time left in the contract. Time value is a component of the extrinsic value of a contract. Time value decreases as expiration approaches and it’s not linear. Rather it is doesn’t really start to move until around 45 days to expiration (DTE) and really is really moving in the last few days of the contract. Time risk is estimated by the greek theta.
  • Volatility risk is, in my opinion, the least understood by new traders. But it is also a component of the extrinsic value of a contract and it quantifies the speed of price movement in the underlying. This one is tough because implied volatility (IV) is, well, implied which means it’s tough to measure until after a move has happened. But it’s important when thinking about the probability of a contract being profitable or not. And, to make matters more complicated, the value of that probability is derived from the live prices of the market. Because of that, it’s not entirely predictable. This could be a topic all to itself, but I’ll leave it here as a summary. Volatility risk is estimated by the greek vega.

Strategy: A Long Straddle

One idea that attracts new traders is the long straddle. In short, a long straddle is an equal number of long calls and long puts at the same strike price and the same expiration. An example of a 32-day long straddle is here:

A 32-day SPX long straddle

As you see, the long straddle makes money if the underlying moves in either direction since you own a long call and a long put. This trade as shown above is what it will look like when the trade is first opened. The graph looks safe..from a price risk point of view. If SPX moves down, the put side makes money, if it moves up, the call side makes money. You have minimized price risk. But the risk of the trade is if SPX stays range-bound and just moves back and forth in a series of normal days. In a long straddle, you don’t just need the price to move, you need it to move a lot in one direction. You need the winning side to make more than the losing side. This is where volatility risk comes into play. You need a large move in one direction. So perhaps you put this on before an event like earnings or you pick an underlying that tends to move a lot anyway. Well, everyone else in the market knows these things too and that will be reflected in the contract prices. If an underlying is reasonably expected to move during the life of the contract, the volatility component of the price of those contracts will be higher. This means your total price of the trade will be higher which, in turn, means you will need an even bigger move to be profitable since you have to make up the money you put into the trade. So you not only need a big move in a particular direction, you need an unexpected big move in a particular direction. And once the event is over, a good amount of that volatility can come out resulting in a “vol crush”. This lowers the price of your options (even the winning side) and can act as a headwind to your profits.

But it doesn’t end there, there’s still time risk. Because both legs of this straddle are long, both are negatively affected by time decay. This reduces the price of both contracts over time and acts as headwind to making money. So, you not only need a large unexpected move in a particular direction, you need it to happen as soon as possible because with each passing day, the hole gets a bit deeper.

This past week we had a large one-day down move in SPX…106 points or 3 standard deviations. Just the kind of move you would want for a trade like this. Given that we put this trade on Nov 15 (11 days prior) here’s a graph of that same long straddle:

A 32-day straddle after a big move

It’s making money to be sure, but it’s up 5.5%. That’s nothing to be mad about however, that’s after a one-day 3 SD move. These kind of moves don’t happen often…this is exactly what this trade needed, and the reward isn’t amazing for the rarity of the event. Part of this is the $200+ dollars of time decay in this trade every day. And what if that big move had not happened? Here’s that trade at the end of the previous trading day:

A 32-day straddle 9 days in with no big move

The trade was down 7% and it took a 3 SD move to get it to 5.5% up. I don’t think it’s a good strategy to count on a 3 SD move to make money on a regular basis. In this case, time and volatility risk can mask the lack of price risk to a new trader.

I’m not saying that a long straddle is a bad trade. If done at the right time, it can be quite profitable. But if your goal is a trade that will generate regular income, the odds of this trade stacked against you.

Strategy: Day Trading Calendars

So the next idea that was proposed was very short-term calendars. Now, anyone who follows my trades (which I post every week on this site) knows that calendars are one of my favorite trades. Very quickly, a calendar spread is selling contracts in a near term and buying an equal number of contracts at the same strike later in time. Because time will decay faster on the short contracts (since they have less time) the trade is positive theta so time works in favor of the trade (within a range). The idea was to day-trade calendars and try to skim off regular small profits and avoiding price risk by not holding the position overnight. Again, I see the appeal of this idea. In some ways, it is the opposite of the long straddle. Time is in your favor and not having a large move is also in your favor. You would lose in the case of a large move in one direction within a single day. So what don’t I like about this trade?

A 2-day SPX Calendar

At first glance this trade doesn’t look too bad considering the goal is to be out by the end of the day. Yes, the range is narrow but that’s because the shorts expire in 2 days. Why so short-term? Couldn’t I just go further out in time and get more room? Yes. But then I won’t get much theta decay to actually make money on the trade. If my plan is to day-trade this, I need the trade to be very near expiration to capture enough time decay to make money. That, in turn, gives me a very narrow range. In this case I have about 30 points on each side. But that assumes I stay in for 2 days. The plan here is to be out by market close of the same day. Why does that matter? Let’s look at a very normal market day. This was not a crazy day, in fact, it’s a pretty slow day (+10.75 / 0.2% / 0.3 SD). It’s the kind of day you think would benefit this trade.

…a few hours later

This is the trade at the close of the day. A definitely loser and that’s on a calm day. Why did the trade not do well? While the time and volatility risks are low since the contracts are near expiration and most of the extrinsic value is gone from the contracts, the price risk is a lot worse than you think because of gamma. Gamma estimates the change to delta and in the last week or so of a contract, it gets very significant. So when this trade was first entered, it had a delta of .47 which is very good. But the gamma was -.30. So with a one point move in SPX, delta would change about 64%. And it only gets worse and the up move continued as you see at the end of the day, delta is now -8.12 and that was on a small move. This is one of the reasons I don’t like expiration week and try to avoid it. The price risk near expiration is much higher than it may appear on a graph.

Could this trade work? Of course. But, again, I don’t think it will win with any regularity. Just like the long straddle needed an unusually large move to win, the day-traded calendar needs an unusually small move to win. These trades, in my opinion, are highly speculative and not low risk even though they may appear to be low-risk at first.

So What Can Work?

Every trade has risk and can lose and it’s easy to pick apart a trade idea and show how it won’t work. But I would be remiss if I didn’t give an example of what I consider to be a good balance between risk and reward. This is not to say that this trade is good for everyone. It can lose money and certain moves can hurt it. I also cannot say that this level of risk/reward is right for everyone or anyone in particular. I have no idea of the skill and experience level of anyone reading this blog. But with all that being said, I would like to present a trade that I like in certain market conditions that I think strikes a balance between risk and reward. It may also help calm down some nervousness involving overnight risk. Overnight (and weekend/holiday) risks are real. But if a trade is well constructed, that risk can be managed most of the time.

Strategy: A 23-day Narrow Calendar

This is real-world example of the last trade I did but I think it works as an example of understanding risk. This is a 23-day Narrow Calendar which is one of my regular trades that I put on most weeks, specifically when the volatility is near the center of the range. Note: Markets can change and as they do, my volatility ranges will change with them. This is based on a range that I’ve been using for the past year and a half, basically since COVID. Because I trade SPX, the VIX is a good estimate of the volatility. This may not be the case for different underlyings so you’ll need to understand the volatility of your particular contracts. But when I put this on VIX was 16.9 which is on the higher side of the middle. This is why I like a narrow calendar. I define a narrow calendar where the longs are less than a week away from the shorts. This is only possible in underlyings that have mid-week expirations, but SPX does. This is the trade when I opened it.

A 23-day Narrow Calendar

The first thing you should notice is the room on each side. Because the shorts are 23 days away, I have between 1.5 and 2 standard deviations of room. This is based on a single day, but that is relevant since the concern is overnight risk. The odds of open open that will go beyond my range is very low…possible but low. And this is how the open looked the next day.

The next day at the open

SPX opened up 8 points. Not a problem at all, in fact, I’m up a bit in the trade. For brevity’s sake let’s look at the close of the week (2 days later).

…2 days later

So when the trade went on SPX was at 4693 and 2 full trading days later SPX is at 4698. So the trade is fine. But what about a bigger move? Not a crazy big move, but perhaps more typical market open. Let’s see what happened when I held this over the weekend.

..Monday morning

SPX opened up 23 points (0.5%, 0.67 SD) and the trade is not only fine, but it’s doing very well. In fact, this trade came off around mid-day for about 8.5% (not bad for 5 calendar days). Would it have been doing well had SPX moved 100 points at the open? Probably not. But how often does that happen? Not very often. (Interestingly enough SPX did have a large down move later that week so it’s possible but it’s not common. Maybe a few days a year).

The point of showing this trade is not to promote it or say anyone else should do it but, rather, to help you better understand risk and how it can be managed. This starts with a good trade plan. Had SPX made bigger moves, I had a plan to handle it. In this case, I didn’t need to do anything as the market behaved quite normally. But with any trade, you must be prepared for abnormal things to happen.

My goal in this post is to help demystify risk in the options market. First by identifying the risks and then looking at strategies to face the risks with some examples that look less safe than they are and by showing how I use my understanding of risk to set up a trade. As always, I welcome further discussions on this or other topics relating to options trading. Please reach out here on the site, or to me directly at midway@ Who knows? Maybe you will inspire a new blog post.

The Poor Man’s Covered Call

When folks first get into options trading, one of the most popular options strategies out there for beginners is the covered call. The idea is that you own 100 shares of stock and you sell a call against the shares (1 for every 100 shares owned). The idea is that you get paid to wait for the stock to go up and you get some downside protection if the stock goes down a bit since the call will lose value allowing you to potentially keep more of the premium. The primary risk of this trade is exactly the same as owning the stock. There is some opportunity risk if the stock goes up past the strike of the call you won’t profit much beyond the strike price. But in this case you won’t lose money in absolute terms which makes it a low stress trade. The shares can be called away but the trader gets to set the price so as long as that price is a good one for the trader, it’s not a bad outcome. Ideally, there will be an opportunity to sell multiple calls against the shares over time thus lowering the cost basis of the shares, thus adding to the potential profit of the position. Some folks take this further and pair this strategy with cash secured puts to acquire shares as well. This is commonly called “the wheel” and is a topic of another day.

So, once a trader is comfortable with the covered call, the next question becomes, “Can I do this without owning the shares?”. And the answer is yes. This is done by creating a long diagonal spread. But not just any long diagonal spread, rather one that mimics the risk profile and reward of a covered call. This is known as a “Poor Man’s Covered Call” (PMCC). The “poor man” idea is that it can be done for less money than a full covered call. How much less will depend on how closely the trader wants it to behave like a regular covered call. This is done by substituting 100 shares of stock with a deep in the money long call. This call is usually far out in time. Then you can sell a call against each long call you purchased nearer term just like you would in a standard covered call. This creates a long diagonal call spread but if done in this manner, the risk profile can greatly resemble the risk profile of a covered call.

My Approach to the PMCC

Because this is a popular trade with new traders, I see questions about it on options forums all the time. I’ve answered the question so many times that I thought it was worth doing a longer form explanation here on the site. In the spirit of transparency, I will state that I don’t trade this all the time. It’s not one of my regular monthly trades. But it is a trade I will do occasionally. I’d estimate in 2020, I did this trade about 6 times. But I think my approach to it as a solid one. If you disagree or have other ideas, feel free to comment below. I’m always open to hear other ideas on trading. When I have traded it, it has worked out well so I think the approach is reasonable. Of course, there are no guarantees in this business so if you learning any new trade you should start small (or even on paper) to control your risk while learning it and scale up over time as you become more comfortable. These are just my guidelines with respect to this trade that constitute my trade plan.

The Setup

Every trade plan starts with a setup. There are many different ways to start this trade each with advantages and disadvantages. To me, the important concept of the setup of a PMCC is to get a very similar risk profile while still putting up less overall risk. There is no perfect setup. Every setup has trade-offs. The primary trade-off of the setup of a PMCC is cost vs risk profile. The closer the risk profile is to a real covered call, the more the trade will cost. This makes sense because if it were possible to get a 100% match on the risk profile for significantly less risk, why would anyone do a real covered call?

That being said, my setup is pretty simple. I look to buy my calls about 6-9 months out at about an .80 delta. Is this perfect? Of course not. But I think it’s a good balance of trade risk vs risk profile compared to a covered call. The further out in time you go, the more opportunities you have to sell calls multiple times against you longs, but the higher the cost of the long calls. The deeper in the money you go, the more it will resemble the risk profile of a covered call, but the cost will be higher.

Once I have selected my longs, I will sell my shorts around 30 days out around a .30 delta. This is where you have some flexibility as well. If you are used to selling covered calls, you can sell the same calls you would sell against your stock. If you prefer to nearer term options, that’s fine. If you like to sell a different delta, that’s fine too. It’s always a good idea to look at the model in your broker’s platform and ensure that you are comfortable with the risk profile and the total risk of the trade. You most you can lose is the debit you pay for the trade (unless you adjust, then it will change by the amount of the adjustment).


In the ideal scenario, there would be no adjustments. You put this trade on and simply continually sell calls against your longs until the long is ready to expire, then you close the entire position and make a nice profit both from the longs and the multiple shorts over time. But the market does not always cooperate, so it is important to have a trading plan that includes what you will do in every situation. You don’t want to be in a position where you are looking for help while an active trade is moving against you and you don’t know what to do. All of my adjustments (short of taking off the entire trade) involve only the shorts. I do not like to adjust the longs. In my opinion, there is a fine line between adjusting an existing trade and closing a trade and opening a new one. To me, rolling the longs is creating a new trade. Others may certainly disagree, of course. But it’s very easy in trading to try to fool ourselves into not taking a loss by endlessly adjusting a position. Every trader does this at some point, myself included. I think it’s important to look at trades clearly and honestly. Do not be afraid of taking losses. Everyone takes losses at some point. They key is to manage them properly and endless adjusting is a very easy way to allow a bad trade to get out of control. Again, I speak from personal experience here.

My first adjustment is based on the value of the shorts. There is a temptation to want the shorts to expire worthless thereby keeping all of the premium. Most of the time I think this is a bad idea. I think it’s more important to look at the reward vs the risk of the position when deciding when to take off (and potentially re-deploy) the shorts. My rule of thumb is when the short has lost 75-80% of the premium paid for them, it’s time to close them and potentially roll them out in time for another run. Trying to squeeze out that last bit of extrinsic value isn’t worth the risk to me. Another condition that would cause me to close the shorts is expiration week. I have no desire to hold the shorts open later than 2 days to expiration. Most of the time, I will close them before this. I have no desire to go to expiration, the risk is too much for the last bit of extrinsic value left in the contracts. Finally, if the underlying stock has a dividend, I would close the short before the extrinsic value of the contracts meets the amount of the dividend. This is to avoid early exercise of my short calls. This is especially true close to the ex-div date, but I would follow this at any time. My goal is to avoid the exercise of my shorts and following these guidelines will do that the vast majority of the time.

My second adjustment condition is based on the share price. If the underlying stock price drops, the value of the short calls will drop with it. However, there will come a time when the short is no longer providing any more protection against the downside. At this point, I’m not interested in having this short on my trade and I’d prefer to roll it down (and possibly out in time) to get more downside protection and to bank a bit of profit on my shorts in the process. I will show an example of this later in this post. This isn’t free. In exchange for more downside protection and the banked profit, I will give up more potential upside profit because I am rolling down. If the stock rebounds past my short strike, the amount I can participate in the price gain will eventually stop because of the short.

Closing the Trade

What if the price goes up beyond the strikes of the shorts? This means the shorts are now in the money and are probably worth more than the premium received due to intrinsic value. This is where I see the most questions in options forums. Usually the question is about the shorts getting exercised. As I’ve already stated it is never my goal for my shorts to get exercised as that is not why I am in this particular trade. So what’s a trader to do? You can certainly wait and see if the stock comes back down. Maybe it was just a temporary spike and doing nothing is the right answer. But be cautious here. I would only do this if I had at least 50% of the time left on my shorts and the breach isn’t very far above my shorts. It’s OK to wait a bit and see if things move back in the preferred direction, but hope is not a strategy. At some point, you may need to act. My next guideline is to simply take the entire trade off for a net profit. If the shorts are in the money, you will lose by closing the shorts, but you should have gained more with the longs due to the delta difference between them (remember I am buying around a .80 delta vs selling around a .30 delta). So the entire trade should be profitable. Maybe it wasn’t the profit I wanted when I set it up, but it’s a profit and there’s nothing wrong with taking it. How often does a trade move against you and you still make money? There’s no law that I can’t take a trade off now, wait a bit for things to settle down, then put a new trade on later and try again if my thesis on the underlying is still reasonable.

And let’s never forget the best reason to close a trade: You reached your profit target. Every trade plan should have a specific profit target. This can be a dollar amount or a percentage of the risk, but it is a critical part of the plan. The biggest enemy here is greed. If your plan is to get 20% on a given trade, and you can close it for 20%, close the trade. Getting greedy is a great way to lose. Now, if you’re doing so well that you can bank your profit target by only taking off part of the trade and you want to play with the rest, that can be done. Just always keep in mind that whenever your trade is on, you have risk. The primary job of a trader is risk management. Do not add risk back to the trade when you do this. The whole point of doing this is to realize your profit and continue with significantly reduced risk, ideally so little that if you lost it, you would still make money overall on the trade. The bottom line here is that every trade plan should have a specific profit target and it should be respected. When the market gives you what you ask for, take it.

Finally, just like every trade plan needs a profit target, it also needs a maximum loss which should also be shown respect. In this particular trade, the biggest risk is the stock dropping and approaching (or even crossing) the strike of the longs. There will come a point when rolling the shorts for more credit makes the trade ultimately unprofitable. If either of these things happen, it’s time to close the trade for a loss and move on. This is probably the hardest part of trading, but it must be done. Even though this trade should work the majority of the time, it can lose and you must be prepared for that possibility.

A Real-World Example

So I’ve gone over the theory of this trade as well as my approach to it, but there’s nothing like seeing it in the real world. This is one example of a trade I did earlier this year in Delta Airlines (DAL). I did several PMMCs on this stock in 2020 with some reasonable success. But I think this particular trade demonstrates some of the concepts I discussed earlier.

So I opened this trade on May 4, 2020. DAL was trading at about $22.35 at the time I opened the position. I bought a Jan 15, 2021 Call (about 7 months out) at the $15 strike which had a delta of 81.85. I then sold a June 5, 2020 (about 32 days out) call at the $25 strike price which had a delta of about 38. My profit target was 20% and my max loss was 25%. The rationale behind this trade was that DAL pulled back about 7% that day (this was during the pandemic) so my forecast was that it would rebound a bit from that. I paid a net debit of $836.30 for the trade so the trade was a a reasonable discount to owning 100 shares of DAL. This is the risk profile at the start of the trade.

Initial setup of DAL PMCC

So 9 days later, on May 13, the stock had dropped to $20.13 and the trade is down $110 or about 13%.

Day 9 of the PMCC..not good.

Not what I wanted, of course. But the good news is that my short for which I collected $1.30 of premium was not trading for about $.30 or about a 75% discount. This meets both criteria for my guidelines for rolling my short. In this case, I choose to roll down to a $23 strike and out 2 weeks to June 19 for a net credit of $.74 (bought the short back for $.30, sold the new one for $1.04).


The result of this roll is that I have more downside room and I banked a bit more credit, but my upside is more capped since I rolled down. That green 20% target line is going to be tougher to reach. Because of this, I’m willing to take a bit less should the market give it to me. It’s possible I could end up rolling again which could put 20% back in play, but for now, I’d be happy with perhaps 15% depending on what happens.

Not much happens the rest of that week, but the following Monday, DAL makes a nice gain, nearly 14% so the trade is at least starting to make money again.

That looks better

As you can see, my short has gained value (now trading at $1.66) which hurts the trade but the larger delta of my long has made the overall trade profitable.

A little over a week later, DAL popped again now trading at $25.35. My short has jumped to $3.60 but, again, my long has pushed the trade up even more.

Now that’s more like it

At this point, I could try and wait it out and get the full 20%, but I go ahead and take a bit less. This is still a nice profit and I’m glad to take it. I don’t want to roll the short because getting a net credit at this price would be next to impossible (I’d have to go way too far in the future which breaks the trade structure) and I don’t want to roll for a net debit. So, I simply take the trade off for a nice albeit slightly lower profit than my target.


This is how I approach the PMCC. It is certainly not the only approach, but I think it’s a good place to start if you are new to the trade. You may make your own adjustments to my trade plan that that’s fine. What is far more important is that you have a detailed trade plan for this and every trade you open. This plan should have all of the elements I have described here: a setup, a profit target, a maximum loss, and adjustments for each direction. Once you have this, trading is more a matter of execution. That doesn’t mean every trade will work (I have lost on this trade with this plan) but you should be able to control the losses and be overall profitable with practice.

If you have questions, comments, suggestions, please feel free to reach out. I really like talking options trading so feel free to comment below or you can reach out privately via email at midway@

Good Trading!

Surviving Wild Market Drops

If you’ve followed my style of trading you know I like non-directional income style trades where I try to make money on time decay (positive theta). Most of the time, this works out well. I do lose on occasion as everyone does but I go into each trade with a plan to handle various market conditions. Most of my trades have enough time that I can adjust them if the market moves too far against my position. This, essentially, allows me to buy more time to allow the trade to work. If you’ve watched my This Week @MidwayTrades series, you’ve seen me execute this plan over and over again. Most of the time on these income trades my adjustment plan involves adding structures such as butterflies or calendars making a double or removing a structure from a double and returning to a single.

But there is one kind of move where this does not always work: A big market drop. I work hard to keep my trades in a good enough position to handle at least a 1 standard deviation move in either direction. Statistically, a stock should move less than that about 67% of the time so this keeps my trade in a relative safe position. On the bigger moves, I can make adjustments as described above. But what about a 2 SD move? Or even more? These moves tend to be on the downside so that’s where I’m going to focus this post. We do get occasional big crash moves and just adding or removing spreads isn’t going to work well because pricing is all over the place. Finding a steady price for 2 or 3 legs in a spread just is not practical, and legging out one at a time can be just as dangerous. You may be able to get out for some price, but that price could be really bad and make a big loss. As traders, we like to avoid big losses so what can we do to try and ride out the crazy storm?

Back To Basics

As one learns more about trading and gets more sophisticated with multi-legged trades, it’s easy to forget why options were created in the first place. In short, they act as insurance to protect a position. Traditionally that position was a long or short position in a stock, but it works just as well to protect a position made entirely of options. And for a big drop, that answer is simple: long puts. A properly purchased single long put can save your position and, in some cases, your account (if it got that bad, I would strongly suggest you are trading too large, but it still works). The simple act of adding a long put to a position at the right time can make the difference between a big loss and a small loss, or even a win. They come with a consequences, of course, so I do not like to use them all the time but, at the right time, a long put is a simple fix to a bad problem.

So this post will look at when I buy them, what I buy, and when I sell them. You may tweak these to suit your style, of course, but don’t think a trading plan is complete without having this as a possible response to a big down move.

When to Buy Puts

Buying puts is not a free pass. First, they cost money. You are sinking money into a trade that has gone badly. If done at the wrong time, you can easily dig a bigger hole for your position and take a bigger loss than needed. In addition to costing money, long puts reduce theta. All long options have negative theta so adding a long put to a position will hurt the theta of the position (maybe even taking it from positive to negative). As one who likes positive theta trades, this isn’t my goal. But when things get really bad, sometimes theta has to take a step back to the threats of delta and gamma (i.e. price movement risk). When delta and gamma get out of control quickly, a long put can stop the bleeding and give you time to catch your breath when things are going wild. This has an added benefit of allowing you to think clearer about your next move. If done properly, the stock can continue to tank and you’ll be just fine. Very few good things come from a state of panic so fixing the big problem in front of you helps with the next decision.

With all that being said, my guidelines for buying a put are the following conditions:

  1. The stock has moved at least 1.6 standard deviations down. Less than that and my regular adjustments should work just fine. This is a guideline so don’t take it too literally but I think it’s a good rule of thumb. It’s beyond this point where prices tend to get weird and buying or selling a spread gets really difficult. But in a big down move, buying a put is easy as there are plenty of folks willing to sell them.
  2. My position is at an adjustment point. There’s no sense buying long puts if the trade is still working even with the big move down. Sometimes, my trade can withstand a 2 SD move down. If that’s the case, there’s no need to add long puts.

What To Buy

So that’s when I buy puts, but now what puts do I buy? The critical idea here is to not buy too much or too little. As I stated before, options aren’t free in terms of cost or in terms of the Greeks so my goal is to buy just enough but not much more.

My guideline here is based on the delta of the position at the time I am buying the put. I want to buy enough to nearly flatten my position deltas such that further big movements won’t harm me. This means I’m looking to cut them around 80%. Yes, that’s a big delta cut but this is in response to a big move. That being said, this usually means I am buying far out of the money. This has the advantage of being less expensive while still getting the job done. If, for some reason, I need a lot of deltas, there’s nothing wrong with still buying far out of the money but buying multiples to get to the target. Which to do would be based on the price of the options you are considering. For example if I needed 40 deltas. I could but a .40 delta put or I could consider buying 2 .20 delta puts. Both will do the job so I would choose which ever is cheaper. Most of the time I don’t need anywhere near that many deltas so a single put will suffice.

But there is still the question of expiration. This depends on the spread I am trying to protect. If it is a vertical style spread where all the options are in the same expiration (this includes butterflies, condors, etc.), then I tend to buy in the same expiration as the spread. The only exception to that would be if there were very little time left in which case I would go further out in time. I’ll explain how far when I talk about when to sell, but as I tend to not be in trades during expiration week, this rarely comes into play. If the trade involves spreads in different expirations (e.g. calendars or diagonals), then I will use the later expiration.

When To Close the Put

The final piece of my hedge plan is when to close it. The temptation here is to look at the price paid for the put and base when to close it on the profit or loss of that put, essentially looking at it as a trade within a trade. I don’t do that. This long put hedge is part of my trade and so I try to look at it in terms of the what it’s doing for my trade. The goal isn’t to make money on the put (although that can happen), but to make money on the entire trade which now has this put as a part of it. So there are 4 times I look to close the long put hedge.

  1. When I’m ready to simply close the entire trade. If I have hit my profit target or my max loss on the entire trade and it’s time to close the trade, then it’s time to close the put along with it. Again, the put is not separate from the trade.
  2. When the market calms down and I can do a proper adjustment. So let’s say we had a big drop and I added a put, but the next day things are calm and a normal adjustment to the trade is now possible. The storm is over, I can buy that new spread or close the upper part of the double. Once I do that, my Greeks will be out of whack due to the long put. If I can do the regular adjustment, I will close the put after I get the adjustment done. Do not do it before because until that adjustment is on, the trade is still at risk.
  3. The trade recovers. Sometimes a big drop if followed by a recovery. Maybe it’s the next day, maybe two, maybe even the same day in a really crazy market. If the market recovers such that my trade doesn’t need the help anymore, I will close the put for a loss. That leads to the question “what is a sufficient recovery?”. For me, a sufficient recovery is if the underlying comes back far enough to cross the center to the structure (or, in the case of a double, the center of the lower structure). There’s a big temptation here to take it off earlier to take a smaller loss on the put. The danger here is that if the stock drops back down again, you bought high, sold low, and potentially bought high again. That’s not a formula for profit. So the key here is to be patient and keep the insurance until the chances of needed it are lower.
  4. Time. Long options have time decay. As they decay, the help they provide your trade diminishes. My rule of thumb is I will keep a long put on for up to 20% of the time remaining when I bought it. So if when I bought the put it had 20 days to expiration, I will keep it for up to 4 days. This would be the exception to the rule above on what expiration to buy. If there isn’t much time left in the spread, then buying the put in that expiration may not make sense based on the 20% guideline. In that case, I would consider buying something further out to avoid having to close it too quickly. If time runs out on the put and I still need the protection, I simply roll it out to a later time with the needed delta help.

Real World Examples

I’ve thrown a lot of information in this post so I think it’s valuable to show some examples of trades I’ve done where I’ve deployed this strategy. This year has certain had some volatility, so it wasn’t too difficult to find examples that demonstrate my methodology.

Back on January 29 I put on a simple butterfly:

This is a common setup for a butterfly for me. It’s an unbalanced butterfly 44 days out, 40 points up, 50 points down which makes a nice flat delta trade with .80 deltas on a 2-lot. However, 2 days later the trade looked like this:

SPX moved 51 points down in a day which constituted a 2 SD move. My trade is at an adjustment point so instead of trying to buy a lower fly, I add a put:

I bought a 2550 put (way out of the money). This is because to cut my deltas by about 80% I needed around 1.75 deltas. But now I’m not worried about the trade getting into trouble on the downside and I can wait it out and see what happens given that I’m really flat so that price movement doesn’t scare me. In return for that, my position is negative theta at the moment. While I don’t like that, I’ll take it for now to help stop the delta/gamma bleeding. When I bought the put it had 42 days left in it. That means I’m willing to keep it on for about 8 days before I need to sell it outright or roll it out. This happens to be a Friday so I kept this put on over the weekend and even into the early part of the week. It wasn’t until Tuesday Feb 4 that the trade looked like this:

Note that we had a big up day that put the stock above the middle of the fly structure. At this point it’s time to sell it off at a loss. I lost a bit over 50% of the value of the put but it was just insurance that wasn’t needed. On the plus side, I didn’t pay much for it and this trade eventually closed for a small win. In perfect hindsight, I could have done nothing and done better but there was no way to know that at the time and it was better from a risk management perspective to buy the put and protect the position so that it did not get out of control and become a big loss.

Another interesting example was on June 10 when I put on a narrow calendar.

This is a very typical trade that I put on for much of this year. In the crazy market we’ve had this year, I really like the initial room this trade has and the relatively low vega exposure for a calendar. However, the very next morning I woke up to this:

So in the first hour of trading SPX is down 2 SD and my trade is at an adjustment point. This was a rare exception where I was able to put on lower calendars as an adjustment. Had I not been able to get a good price on it, I would have gone right to the put, but since I was able to do so it looked like this:

So I got my double calendar on and I have a lot more room now, right? Not so fast, later that same day….

Just 2 hours later, SPX is now 133 points down or 3.3 SD down. At this point there is no way I’m going to try and take off the upper calendars (I was lucky enough to get the lower calendars on when I did), so I go ahead an buy a put:

By buying a 2400 put in the back side of the calendar I was able to cut my position deltas to 1.8 from 5.4 and stop any more bleeding. The next day, the market calmed down and I was able to properly take off the upper calendars. At that point I was able to sell off the put since, with my proper adjustment, it was no longer needed.

Now the trade is back to normal and, in this case, I was able to sell the put off at a profit. While that was never the goal, it was a nice bonus. This trade ended up doing very well (over 30% profit) and it was made possible by being able to weather the quick storm that came through the market.

In these examples I used long puts to save trades that got hit by a big market drop. Long puts are not a cure for every trade. I have used these and still lost money, although not as much as I would had I not bought the put. But long puts can be the right fix for a crazy down move.

Hopefully you found this helpful. I’d love to hear what you think or other ideas you may have to handle these kinds of big moves. Feel free to comment here or reach out me directly at midway@

Why I Avoid Expiration Week

As I interact with options traders (mostly online), I see the topic of expiration come up quite a bit. I see lots of questions about what happens when options expire, especially in the money options. While I think it’s good to understand the terms and conditions of options contracts, I do not believe it’s usually worth putting oneself in the position where expiration is going to be a problem. In fact, I not only avoid expiration day I avoid expiration week and will explain why in this post.

Exceptions to the Rule

Before getting into why I don’t like expiration week, let me say that much of this has to do with how I trade. I’m not saying that every strategy, or even every successful strategy should never go to expiration. There are perfectly good strategies that expect to take contracts to expiration. One such strategy is known as the Wheel or I’ve seen it called Laddering. The idea is that you sell cash secured puts on shares you wouldn’t mind owning. Then if you get assigned, you sell covered calls against those shares at a price you already like. While this isn’t the way I trade, it’s a perfectly good options + stock strategy. But notice, I said “+ stock”. This strategy explicitly plans to own stock at some point in time. If a trading plan includes this, then going all the way to expiration is perfectly acceptable and, perhaps, even desirable.

Another example could be a vertical spread that is very far in the correct direction that going to expiration yields maximum profit and the risk of losing is very low. In this scenario, I would prefer a credit spread so that everything expires worthless and there is no assignment mess but it can work with a debit spread. While this carries a bit more risk than the wheel, it’s reasonable under these conditions to go to expiration.

There may be other exceptions to my rule but these are two off the top of my head. But now I’ll talk about why I don’t like expiration week.

What I Don’t Like About Expiration Week

If you’ve followed my trading videos at all, you know I like to trade non-directional spreads on large indexes (usually SPX). One of the many reasons I like doing this is that I don’t like picking direction and I don’t want shares (SPX is cash settled since there are no shares unlike SPY). There are occasions when I may trade an underlying that is share settled but, in any case, I have no desire for shares of stock in my options account. It’s just not part of my strategy. Because of this, expiration day and even expiration week cause more headaches than they are worth.

High Delta and Gamma

The main reason I don’t like expiration week with the types of trades I put on, it’s almost impossible to stay non-directional which is one of the main goals of my trading. I trade mostly calendars and butterflies which both have expiration graphs that look like tents. In fact, in my videos you’ll sometimes hear me refer to the tent of the trade. But for most of the trade, the T0 curve, which reflects today rather than expiration looks nothing like the tent. See an example below:

A 24-day Calendar on day 1

This is an example of a 24-day calendar which is a typical trade I’ve been doing recently. The shorts are 24 days away from expiration while the longs are 5 days away from the shorts. The dark blue “tent” is the expiration graph the light blue arch is the T0 line which represents the risk today. Note the difference between the two risk lines. As the trade gets closer to expiration day, the two lines will converge, slowly at first but very rapidly in the last few days. Note the slope of the T0 curve. It’s quite flat and manageable and I would consider this trade reasonably non-directional. And the Delta and Gamma values reflect this as they are both very low. As the underlying moves in either direction, the effect on the position is not very much, at least until you get outside the tend at which time the slope starts to get steeper. However I have a reasonable amount of time to manage the price risk as the tent covers about 2 standard deviations for 1 day. The odds of this trade staying in my tent in one day is around 94%. Not guaranteed to be sure but pretty good odds and even if it does go outside the tent in a day, the odds of not getting a chance to manage the trade is even lower. This is a pretty manageable trade, in my opinion.

Now let’s look at the first day of expiration week:

A 24-day calendar on day 20

So this is a theoretical view of that same calendar on day 20 (the Monday of expiration week). Now the change in the T0 line is much more apparent. On the one hand, the profit potential if the underlying stays in the tent is very good. At the center I can double my money. But look at the slope of that curve and the corresponding delta values. Delta gets very big, very quickly and moving much to either side of center can get this trade into trouble very quickly. This, to me, is no longer a non-directional trade once it moves even a few points from the strikes of the contracts. While the potential reward is great, the price risk is too high for me. Take a look on Thursday of expiration week:

A 24-day calendar 1 day to expiration

Now the two graphs are almost aligned which makes sense since expiration is 1 day away. But looks that the Delta values as you get away from the strikes. They get into triple digits very quickly. But also compare the corresponding Gamma values on the 3 charts. The high Delta change rate is driven by Gamma and Gamma is exploding during expiration week. This is why I refer to expiration week as “Gamma Week” because Gamma is driving the risk. Is there a big profit potential? Of course. But it all can vanish very quickly with a decent move and we still have another day in this trade before expiration.

Perhaps your thinking, well that’s just a calendar, what about a wide Iron Condor? Sure, you may get more room on a high-probability Iron Condor. But as expiration approaches, you run the risk of taking a max loss on the trade and the wider you make your Iron Condor the less credit received and the lower the reward for the risk being taken. Can they work? Sure. But you need the stomach for the end of the ride. For me, the risk/reward of wide Iron Condors is not attractive.

Assignment Is a Hassle

Just my opinion here, but dealing with assignment scenarios when I do not have the goal of buying/selling the stock is just not worth the hassle. As you saw in the above example, the risk/reward gets crazy but in addition to that, there can be assignment fees which can cut into the profits as well as tying up capital to squeeze out those last few dollars out of a trade. Taking all of that into considering, I’d just rather avoid it altogether.

Avoiding Assignment

Fortunately, avoiding assignment is relatively easy. Assuming the underlying is settled in shares, you can avoid assignment in almost all cases by doing the following:

Close Before Expiration

This is the most obvious one. Just don’t be there when expiration happens. Take most of your profit and move on to the next trade. If your position isn’t open, you can’t be assigned.

Be Aware of Dividends

While most underlyings are “American Style” which means they can be assigned at anytime before expiration, this rarely happens. The #1 reason this does happen is dividends. If the dividend is worth near or more than the extrinsic value on your short calls, there’s a good chance the shorts will get exercised and the shares will be called away at or near the ex-div date. The good news is that the dividend amount as well as the ex-div date are public knowledge, so with some planning, it’s easy to avoid this situation as well. Don’t have a short position on if there’s a reasonable chance someone would want to buy the shares to collect the dividend.

There are some rare cases that you can’t always anticipate. The only time I’ve had shares called away early was due to an acquisition. I sold some calls against some shares I owned and the company was bought by a larger competitor at a good premium. My shares were called away the very next day (it was announced after the market closed). In cases like these, there may not be much you can do to avoid early assignment. But fortunately, this is very rare.

What Do You Think?

So, this is why I don’t like being even close to expiration. It just doesn’t fit my style of trading. That doesn’t mean it’s wrong on all occasions, but I think it’s important to understand what can happen as trades enter Gamma Week. I see traders worry about what will happen to their trade if all or part of their trade expires in the money all the time. I agree it can be confusing, especially to newer traders. So unless your trading plan includes assignments, just avoid it. Thankfully, avoiding the various expiration scenarios is quite easy to do.

So, that’s my take. As usual I’m always interested to hear what my audience thinks. This is a place for learning and discussion options. So feel free to ask questions, make constructive comments, or start a discussion.

Until next time….Good Trading!

Trade Idea: A Narrow Calendar in a High Volatility Market

This market has been crazy for a couple of months now and this means that traders need to adapt to the conditions. I believe good traders can trade in almost any environment. A big part of my options journey is to learn how to trade in as many different market environments as possible. Only then can I consistently make money no matter what the market does.

As one who has only been trading consistently for about 5 years now this is, by far, the longest stretch I’ve ever seen with high market volatility. As many of you know I primarily trade SPX and my trading plans were built around normal volatility ranges with the VIX in the range of about 10-25. This market hasn’t been in this range since the start of the virus crash which is now been about 3 months. When it started, I did some of my usual alternative trades: trades on non-correlated things like metals, even doing some directional plays like synthetic covered call like I discussed in my last blog post. But this market is now in very new territory for me. VIX has settled down in the mid to upper 20s which is pretty low for the last 3 months but is still historically high. So what’s an SPX trader like myself to do? I usually don’t start going negative Vega trades like Butterflies until VIX is in the low 20s and forget calendars with their high positive Vega, right? Well…maybe not.

At least for now, a relatively low VIX is in the 20s. But that’s still pretty high. Calendars are tempting because volatility is relatively low compared to the last couple of months but it’s still high enough that calendars give you lots of room. But nothing is free in this market. The reason the market gives me a ton of room on calendars is because while a 25 VIX may feel low right now, it’s still quite high and so the risk of a big move is still around. Add in the fact that volatility is mean reverting and we could have the risk of dropping volatility while we’re very long Vega. That wide tent could contract and put the trade into trouble quicker. As I’ve stated in a previous blog post, when I set up my usual calendar in a low volatility market, I like to put my longs 2 weeks away from my shorts. This give me a nice mix of price and Vega exposure. The further out in time, the more expensive the calendar and the more Vega you get. This is because the longs will have more extrinsic value than the shorts so they will cost more and that extrinsic value will decay faster as the distance between them increases so you get more of a time difference and positive volatility exposure.

So how could a calendar be adapted to fit the market today? Here’s a modified setup that has been working well for more recently. I’ve named it a “narrow calendar” and it has the following differences from my standard calendar:

  • It is shorter in duration
  • The longs are very close to the shorts

To show some examples I need to set some guidelines. I could simply compare two calendars: one with 14 days between the shorts and the longs and one with three days. You will see a huge difference in the Greeks but I’m not this is a fair comparison because the risk is so much smaller. As you can see below:

An 11-day calendar with the longs 2 weeks out

This is an 11-day calendar with the longs 2 weeks from the shorts. The cost is $2291.30, I get very flat delta since it’s at the money and my Theta is 65 and my Vega is 106. Compare that with a one lot where I put the longs 3 days away and I get this:

An 11-day Calendar with the longs 3 days out

So you can see here, I have drastically less Theta and Vega but the cost is about 20% lower since the long is so much cheaper. This can be a benefit if you want to keep you risk down, but it’s not really a fair comparison with respect to the Greeks since they are proportional to size. So I think a fairer comparison is to make the narrow calendar a 5-lot to get similar risk size:

An 11-day Calendar with longs 3-days out (5-lot)

Now with a 5-lot the cost is $2306.50 which isn’t exactly the same but close enough that I think it’s a fairer comparison. The Vega is higher, but if you look at the ratio of Theta to Vega: it’s much better, almost 1:1. Yes, I have a bit more overall Vega risk but the Theta benefit more than makes up for it so my risk/reward ratio is better. And because this is a 5-lot, I’m able to scale this down to lower my risk while the first example is a 1-lot which can’t be scaled down.

So why wouldn’t I always do this style of calendar? The reason there is the volatility level of the market. I usually do calendars when VIX is under 13.5. In that environment, I don’t mind taking on more Vega risk relative to Theta because VIX is low and will most likely pop. But with VIX in the 25-30 range, I like to lower that ratio to help cushion the blow of a volatility drop. Also, when VIX is very low, I expect the size of the tent will be much narrower which will make this structure less appealing than it is now. So I would prefer to get more room by going back to a two week time spread.

Another thing to consider: with most underlyings you may only have Friday expirations so the shortest time you would have is one week. This is why I like doing this in SPX (or if you want to scale it down even more, you can use SPY), because it has Monday and Wednesday expirations so it’s possible to get very short distances between the shorts and the long.

Of course, I cannot say if this trade is right for you or not. Everyone’s experience level is different. If you aren’t familiar with spreads or calendars, you may want to paper trade a few to get the idea. Also feel free to check out my Options Fundamentals series where I try to explain these concepts in more detail for beginners. But it’s a good lesson in the Greeks and hopefully can spark some thinking about how to adapt a trade to different market conditions. If you would like to see how these trades have worked out, check out my This Week @MidwayTrades series around the end of May into early June. You can see my put these on and how I manage them.

As usual, I’d love to hear any feedback or questions on this or about options trading in general. Feel free to reach out here on the site or you can email me at midway@

Stocks vs Options in a Volatile Market

At the time of this post, the market has incredibly volatile. Not only has volatility been extremely high, but it has stayed very high for weeks. In a normal market VIX in the 20’s would be considered high. Breaking 30 or 40 happens but it is usually quick and returns to normal. These are not normal times as VIX has been above 30 for about a month and over 60 for about 20 days. If you’ve followed the kind of trades I like to so via my video series “This Week @MidwayTrades”, you will understand that I’ve had to stop trading that way until things return to normal. I’ve been looking for different trades that I can try at a smaller scale while things are crazy. I think this is a good opportunity to show the power of options and how you can do very conservative trades while reducing your risk over stocks.

As with everything I do online, this is for educational purposes only, not trading or financial advice.

Thinking about Risk

Risk is on everyone’s mind right now but, in reality, it should always be on our minds. Managing risk is not just a trading skill but a life skill. But here on MidwayTrades I focus on trading skills. Every trade has risk whether with stocks or with options. With stocks, the primary risk is price, whether you are long or short, you have price risk in the opposite direction. In the world of options, we have more risk factors. Of course we have price risk, but we also have volatility risk, as well as time risk. (I’ll leave aside opportunity cost at this point, but that exists too). In the options world we use the “Greeks” to help describe the various risks to a position. My “Options Fundamentals” series covers these at a high level if you want to better understand them. But there’s a risk that’s ever more basic than the Greeks: How much can I lose in a trade? The most fundamental way to control risk is by knowing and limiting the total risk of a trade. This is done by the strategy deployed as well as the size of the position.

When I tell people I trade options, the first thing many say is “that’s too risky for me, I’ll stick with stocks”. While it is true that trading options can be quite risky, it’s all on how you set them up. I can create a position with options that is nearly identical to the risk of a stock trade for a fraction of the capital risk.

Long Options vs Stock

The simplest option position out there is simply being long a call or a put. This is the equivalent to being long or short a stock for a given amount of time. How equivalent? This is mostly dependent on which option you buy and it’s Delta. Very quickly Delta measures the price risk of an option if the underlying stock moves up 1 point. When you own a stock, your delta is 1. While this is technically impossible to match with an option we can get really close. The more in the money an option is, the more is will act like the stock. So a perfect at the money option will have a delta of .50 which means it will move up $.50 for every $1 the stock moves. As you go further in the money, the delta will increase until you get get 99%+ of the stock’s movement. Of course, the deeper you go in the money, the higher the cost of the contract. Also, the further you go out in time, the more expensive the contract. But this cost is generally still less than the cost of 100 shares of the stock, mostly due to the fact that it is time limited.

For example, let’s take a reasonably high priced stock like AAPL. Apple currently trades at about $284/share. So if I look out to June (65 days), I can get a .80 delta call for about $4,155. That’s a lot of money until you realize that a call represents 100 shares of stock and to own 100 shares of AAPL today would cost about $28,400. So the call is about 15% of the cost of the shares and it should move at about 80% of the stock. That’s not too bad. It also has similar risk on the downside where it will lose .80 for every dollar Apple stock loses. So the risk/reward ratio is much better and, I would argue, makes this a safer trade. If Apple goes to $0, the worst I can lose with my option is $4155, while with the stock I can lose $28,400. That’s a big difference!

Now, nothing is perfect, so if I’m going to pay 85% more for the shares, what am I getting for my money? Two things:

  • Time. This option expires in 65 days. At that point, it’s only value is the difference between Apple stock and $250 (the strike price of the call). If Apple doesn’t go up in those 65 days, I can lose money.
  • Dividends. Dividends go to owners of stock, not owners of calls. If you like a stock for the dividend, options are not your play.

So while you do give up some advantages of stock ownership, if you look at it from a risk/reward perspective, it may be worth it.

On the bearish side, the risk is not even close. To short a stock like Apple, a broker may require a good deal of margin in the account since the upside risk is unlimited. But if you a bearish on Apple, you can simply buy a put at any strike you wish. Because you long the put, there’s no extra margin worries but you are synthetically short Apple. Just like in the call scenario above, you can pick the strike (delta) and the amount of time, but it is far safer than shorting a high priced stock like AAPL.

Long Diagonals vs Covered Calls

One of the safest options strategies out there is the covered call. If you own 100 shares of a stock, you can sell a call against it to lower you cost basis. If the stock stays under the strike of your short call, you can keep the premium, and can sell another one later if you choose. If the price goes above your strike, you risk having your shares called away at the strike price. This usually only happens at expiration, but there are conditions where it can happen earlier (usually around a large dividend). This is a great strategy and many people use this as their first foray into the world of options (along with just buying a call or put). If done correctly, you can create a small income stream off of stocks you own even if the stock doesn’t pay a dividend. And each time you do this successfully you, essentially, lower the cost basis for your stock.

But as I showed above, owning 100 shares of stock can be expensive vs owning a deep in the money call far out in time. Buying such a call can act as a stock surrogate against which I can sell a call. This strategy is called a long diagonal but doing it in this manner is also sometimes called a “synthetic covered call” or a “poor man’s covered call” because it acts very similarly to a covered call without actually owning the stock. You may see other names for this strategy. Brian Overby of Ally Invest calls this a “Fig Leaf” because you are kind of covered.

So let’s compare these two strategies and compare the risk vs reward. Let’s use AAPL again as I think it shows well as an expensive underlying but this will work with any underlying. So in this example I have a standard covered call in AAPL. I bought 100 shares, and I’m selling a 300 May call against it (a .33 delta).

AAPL Covered Call. Risk: $13,575

This is a typical risk graph for a covered call. The total risk is the price of the 100 shares minus the premium received for the call. In this case that comes to $13,575. Pretty expensive, but AAPL is an expensive stock.

Now let’s compare that to buying a far out deep in the money call and selling the same call against it.

AAPL Diagonal. Risk: $5,980 (.80 delta)

The blue line is the original covered call. The green line is a long diagonal using a January 2021 $230 strike call (.80 delta). As you can see the risk graph is very similar but the total risk is significantly less at just under $6000. Now, the profit potential isn’t quite as good as the covered call, but this is primarily because the stock surrogate is an .80 delta while the stock has a delta of 1. While I think this is a good risk/reward, it’s possible to make the diagonal even closer to the covered call with respect to reward.

AAPL diagonal. Risk $10,190.50 (.93 delta)

In this case I bought a deeper in the money call: $180 strike with a delta of .93. This almost matches the reward of the covered call exactly. However, the risk of this trade is $10,190 which is much closer to the cost of the covered call than the .80 delta. This is why I prefer the risk/reward of the .80 delta, but the risk/reward ratio is really up to each trader.

Back to Risk

So, back to the risk of stocks vs options. In these example I have shown that in terms of real risk (the total amount that can be lost) options, using a conservative strategy and good risk management can be less risky than stock. Of course, there are valid reasons to own stock but I think it’s important, regardless of the vehicle, to understand the risk vs the reward of any trade or investment. Especially in times of market volatility, it’s good to have ways to reduce risk while still getting a good reward and options can be a way to do this.

As usual, I love to hear feedback on all of the content I create. Feel free to reach out here on the site or directly in email at midway@ How do you mange risk? Is this a strategy that makes sense? If you have questions, I’ll be glad to address them. I do this so that we can learn from each other.

Until next time …. Good Trading!

Midway Mail: Questions on My Calendar Setup

I always say I enjoy getting questions and fostering discussions and while I have been getting some very good feedback, I have found some questions that I think can be better answered in this forum than in email. I will keep the viewer anonymous, of course, but I think many traders out there could benefit from my answers and even come up with other (better?) ideas as well. I’m here to learn just as much as anyone so maybe someone out there has some better ideas and I’ll change my mind. All good stuff.

The viewer has some questions around the calendars I put on over the last few months. If you aren’t familiar with Calendars, check out Episode 13 my Options Fundamentals series. It should give you the basics of the trade and how it works.

Question 1: Why do my calendars more often than not start on the call side?

This is a great question and there isn’t one correct answer for everyone with respect to which side to use when setting up a calendar. When considering this, the first thing to determine is why you want to put a calendar on in the first place. This seems obvious, but I’ve seen lots of new traders put on trades without knowing why. There are traders who put on calendars to get a cheaper long call or put. They really want to be long a call or put but want to sell something against it to help pay for it. In this scenario, the ideal situation would be for the short to expire worthless leaving them with just a long call/put at a cheaper price since they got to keep the premium from the short option. In this case, it really matters which long option you want to have if the trade is successful. You really want to be directional, so you would choose the direction you want by choosing calls or puts.

However, that is not why I put on calendars. I am not a directional trader (outside of a rare speculation play) so for me, calls or puts isn’t nearly as important for my calendars. The reason I put on a calendar is that it is positive Theta and Vega and there times when I want those factors working in my favor. I almost always like Theta to be positive as I prefer time to work in my favor, but if the volatility of the underlying is low, I would rather be long volatility when trading it. I believe fundamentally that volatility is mean reverting, meaning that it always returns to the average. So when the volatility of my underlying is low, I would rather be long volatility since I believe it will go up. Conversely, when volatility is high, I like to be short volatility (negative Vega) since I believe it will go down. Of course, I cannot know how long it will take for this to happen, but the idea is to set up my trade to have the best chance to be helped by volatility. Since I also have time working in my favor, I can profit from that even if I don’t get the volatility move I expect, it just may take longer to get to my target profit.

Now that I’ve explained my goals of a calendar, I’ll try to (finally) answer the question. The answer is that, for me, it doesn’t really matter whether I start my standard at the money calendar in calls or puts. I intend to take it off as a spread so I’m not worried about which long I will have left. So how do I choose? I look at the open interest of the calls and puts that I intend to use and I pick the side that has the larger overall open interest.

So what is open interest? It’s a count of how many open positions exist on that particular option. It doesn’t matter if that open position is long or short so long as it’s open. This statistic gives us an idea of the liquidity of that particular option. The more open positions, the more interest there is in that particular option, the better the chance of getting good fill price with little to no slippage. Again, there are no guarantees here, but the idea is to put on a trade with as many factors in its favor to succeed. So if I have time on my side, potentially volatility on my side, and good liquidity so I’m not paying up for the position, I should have a better chance of success. Of course, price risk is always there as a calendar has risk on both sides as it’s a range-bound trade. But as I always say, this market pays me to take risk so there will always be risk somewhere.

So why did I end up choosing calls to start my position more often? Because during that time, the market was trending up which made calls more popular than puts. There could very easily be other times in the market when puts are more popular. So the preference for calls simply resulted from more open position in calls most likely caused by an upward moving market.

Let’s take a quick example. Let’s say I wanted to put on a calendar in SPX right now (note: I would not do that as volatility is too high, but this is just an example). I’ll do my usual shorts about 24 days out and my longs 14 days later (more on that later). Let’s look at the open Interest of each of my options:

Open Interest on shorts of a potential calendar

So, let’s assume I want to set up a calendar at the 3300 strike. So I choose 24 days for my short, and compare the open interest in the calls and puts. As you can see, the calls have a large advantage. But let’s also look at the options 14 days later.

Open Interest on the longs of potential calendar

So, in this case, the puts have a slight advantage over the calls. But it’s not enough to overcome the advantage of the shorts so I would start with calls here. It turns out today was a large up day so, again, it’s not surprising that the nearer term calls had such a large advantage.

None of this is to say that choosing the puts would be bad or wrong. Remember that using calls or puts doesn’t really matter to my calendar since I’m not worried about keeping the longs. And if I were to adjust the trade, I would most likely put on another set of calendars and I would use the puts for that to help keep my two calendars separate.

Question 2: Why are your calendars 2 weeks between the legs?

Another very good question and, again, there isn’t a perfect answer here. This has become a matter of preference for a couple of reasons. The first is this is the way I was originally taught to do the trade so there is some bias there. But, I keep doing it this way as I like the balance I get of risk and reward. All trades have risks and rewards and that ratio can be adjusted based on how the trade is entered.

As a quick reminder, a calendar is where I sell options and buy the same number of options at the same strike at some point later than the options I sold. It is this structure that gives the calendar it’s characteristics of being long Theta and long Vega. Why? A nearer term option has faster time decay than the same option further out in time. And in a calendar I am short the nearer term option so that is what gives me my time benefit (positive Theta). To get positive Vega, I buy my longs further out in time. Options further out in time have more volatility risk and since I am long the option that is further out in time, I get a positive Vega position.

So how does distance between the strikes affect the Greeks of the position? The further the distance in time between the legs, the greater the difference in the rate of time decay and so the result is more positive Theta. Similarly, the greater the distance in time between the legs, the greater the difference between the volatility risk and so the result is more positive Vega.

So why would I only choose 14 days? Surely, it would be better to increase the distance between the legs and get really high Theta and Vega working for me, right? Of course, there is no free lunch in this market and the price to be paid for having a large distance between the legs of a calendar is … price. In a calendar I am buying the further out option which has more extrinsic value (time and volatility) while being at same strike. This means that the greater the distance between the legs, the more the price of the longs will be compared to the shorts, which yields a higher debit for the trade which, in this trade, is my total risk. So I have to pay for the extra Theta and Vega with money from my account because the trade is more expensive. Let’s look at two examples:

A 24 day calendar with 1 week between legs

In this example, I have a simple calendar with the short 24 days out and the long 1 week later. This gives me 6.77 Theta and 46 Vega and will cost about $900. Now let’s push the long out to 6 weeks from the short:

A 24-day calendar with 6 weeks between legs

So this the exact same calendar but with the legs 6 weeks apart rather than 1 week apart. Here I get 32.84 in Theta, and 191 Vega which is much longer for both. But the cost of the trade is now $2726. So I have to spend about 3x more in capital to get the boost in Theta and Vega. That may look like a bargain, and there’s nothing wrong with taking that trade, but remember that Vega is a 2-way street. While it will be great if volatility goes up on this trade vs the 1-week trade however, if volatility goes down, I get hurt that much more as well. The other risk to consider is Gamma risk. While my deltas on these trades are similarly small, the Gamma is higher on the 2nd trade. While Gamma starts out small on both trades, the it will move Delta faster on the wider trade than the narrower one. This increases my price movement risk in a live market even though Delta starts off very neutral on both trades.

The Choices are Yours

I say all of this to say there is nothing bad about either trade as long as you, as the trader, understand the risks vs the rewards. There are many ways to set up a calendar to make these risk decisions. It’s up to the individual trader to decide what risks are worth taking versus the reward of the trade succeeding. A blog post is not the place to cover all of those possibilities but I did want to address the specific risks as it related to the questions asked. I hope this helped clarify what I’m doing as well as get you think about how to set up your trades.

Thank you again so much to the viewer who asked these questions. And I am very open to further questions or thoughts on anything on this site as well as trading in general. Feel free to follow-up here on the blog or reach out to me directly at midway@

Until next time….. Good Trading!

Pets vs Cattle: My Biggest Trading Lesson

In the years I’ve been trading, I’ve learned many things. Of course, I started out with the mechanics of options, the Greeks, the strategies, etc. If you are interested in these fundamentals, check out my video series Options Fundamentals here on the the site or on my BitChute channel. I go over many of those early lessons about options trading.

But the craft of trading is more than just understanding the mechanics. Trading is also psychology. Paper trading is a useful tool, but you will never get the full experience until you are trading live money, your hard earned money. The ups and downs of the market become much more meaningful. It’s easy to get obsessed or stressed about your trades. The financial investment can lead to an even bigger emotional investment. Your idea is sound. Your plan will work. You have the skills to fix things when the market moves against you. You will make that profit. While confidence is certainly needed when one is in the risk management business (and that’s how I see options trading), you must be able to look at your trades as assets in your business. After all, what are options? They are simply contracts, a set of obligations that we exchange with others. They are derivatives of pieces of paper that represent ownership rights. Or in my case, as one who trades mainly the SPX, I trade a derivative of a derivative of pieces of paper which represent ownership rights

Why do I say all of this? Because recognizing this has helped lead me to the biggest lesson I’ve learned in trading so far. And the analogy I use is “Pets vs Cattle”. Bear with me for a bit and (I hope) it will all make sense.

If you have pets, as I do, you understand that they are more than just animal companions. To many of us, our pets are part of our family. We do our best to take care of them, feed them, get their shots, make sure they have the best life we can give them. When they get sick, we collectively spend billions of dollars a year getting them the best medical care we can. When they die, we mourn them. And, outside of truly obsessive behavior, all of that is perfectly fine and normal. We take in these animals, keep them in our homes and our lives and treat them and protect them as our own.


A farmer or rancher also has animals. He takes them in, feeds them, and protects them. But it’s very different. Those animals are not part of his family. His goal is to eventually sell these animals to make his living. If one of his animals gets sick, he is far less patient with medical care. Time and costs matter and he can’t let one sick cow infect the entire herd. While he may try some limited things to make that cow better, if that fails the cow must be put down and he moves on and focuses on the rest of the herd. To the rancher, the animals are a business asset. They exist to make him money to feed and protect his family (and his family’s pets). But he doesn’t have the emotional attachment to his cattle like he has with his pets.

So, let’s bring this back to trading. After learning the basics of trading, I struggled mightily with consistency. I knew how to win. But for ever few wins I’d get, one loss would wipe most, if not all, of those wins out. I just couldn’t get ahead and actually make any money that way. Losses happen in any business. You can’t avoid them. If you never lose, you never really took any risk and, as I said earlier, risk is how the options market pays traders.

So, I started critically reviewing my trades, especially the big losses. I needed to find what was common in my losses as well as what was common in my wins. And what I found was that when I would lose too much, most of the time I was holding onto a position too long trying to fix it and try make it profitable. I was adjusting my positions every time they went against me and was sticking with them stubbornly to try to make a bad trade work. In short, I was treating my trades like pets. I became emotionally attached to them. I knew if I just did more more adjustment, it would come back. This would go on until finally I was down so far that I finally gave up. A trade that I was trying to make a 10% profit was now down 35-40%. And when I tallied up my trades at the end of the month, it was those one or two bad losses that was the difference between a good month and a bad month.

I needed to change my attitude. I needed to see these trades for what they really were. My trades are my cattle. And like any herd of cattle, some won’t make it to market and that’s ultimately ok. But I can’t let one sick trade infect my account. Every trade takes up capital in my account. There are times when the best thing I can do is close the trade and re-deploy that capital into a new one that could be a winner.

So how am I applying this to the real world? First, before I put on a trade I always have a plan. That plan starts with the setup of the trade, the profit target, and the max loss. But the plan goes further. It also states what I will do when a trade moves against me. I have a plan for the upside as well as the downside. My plan then has the details for subsequent adjustments if needed. That’s all well and good, but I needed something more because just doing that wasn’t helping me avoid these bad losses. So I added some guidelines to my plan which I call my “Pets vs Cattle” rules to remind me of why I made them.

Guideline #1: I don’t adjust in the first 3-4 days. What I found was that when my trade went against me early and I started adjusting, I rarely made it back and it would have been better had I just closed the trade instead of adjusting at all. My trading style relies on Theta (time decay). Because I sell more extrinsic value than I buy, time works for me. But adjustments cost money, either by putting more cash or margin into the trade or taking a loss on part of the structure. So I’m sinking more capital into the trade to, essentially, buy more time for it to work. But if I do that very early in the trade, I haven’t really accumulated much time decay from which to draw. So I was digging myself into a deeper hole before realizing much Theta in the trade. And when I looked at the position at the first adjustment, it was usually a small loss or sometimes even a small gain or near break even. Here’s an example:

An example of a good loss.

So here I had my standard SPX 45-day butterfly. This shot was taken 3 days into the trade and I was already just outside of my butterfly tent. This is normally an adjustment point for me. But, instead I took the trade off for a loss of about $13 after expenses. On a $1300 trade, that’s about a 0.7% loss. Could I have adjusted here and saved it? Maybe. But if the trade goes against me this quickly, I’d rather just take it off and re-deploy the capital. Making up $13 on another trade is much easier than making up a max loss. This trade is cattle and I’d rather not sink more money into it if it’s not working early. Had this been day 5, I’d certainly consider adjusting, but not on day 3. (At 4 days, it’s a judgement call, thus the guidelines says 3-4 days).

Guideline #2: I consider taking off a trade that is at an adjustment point and up money. So assuming I’m past at or past the 4 day mark, if I’m at an adjustment point and up money, I could adjust it and try for more. But, more often than not, I’ll just take it off and re-deploy the capital. If the market gives you a profit, there’s nothing wrong with taking it. Generally if I’m up at least 4%, it’s a no-brainer to take it off. Less than that is when I’d consider adjusting since I’m getting close to break even.

Guideline #3. I limit the number of adjustments to around 4-5. Another observation I noticed in my bad losses was I was over-adjusting. This is somewhat related to the guideline #1 as adjusting too early can lead to over-adjusting. But as each adjustment costs money at some point I have to stop digging and move on. If I hit this limit, I take off the trade even if I’m not yet at my max loss. If I’ve adjusted 4-5 times in a trade, that’s a sign that the market conditions aren’t good for that particular trade and it’s best to take it off and either wait for things to calm down or put on a trade that is more conducive to the current market.

Ok, this blog would not be complete without an example of not following these rules so here it goes. On this trade back in 2018 (before I established my guidelines), I was doing an Iron Butterfly. My first adjustment came in day 2. I then went on to make 8 adjustments before taking a bad loss. Here is what the trade looked like on day 2 when I made my first adjustment

Bad Loss – Day 2

So, at this point, this trade isn’t in good shape. I’ve been in it for 2 days and I’m at an adjustment point and I’m $324 down or 11.5% on the trade. But I can fix it, right? I have an adjustment plan that will make this all better. Well, here’s what it looked like when I finally took it off after 7 more adjustments on day 15.

Bad loss after 8 adjustments in 15 days!

Ugh! I finally closed it for a loss of $1,145 or about 40%! So as bad as it may have felt to have lost $324 after 2 days. I’d take that over losing $820 more. But I was treating this trade like a pet, not cattle. Had I just cut my losses on day 2, I would have lost $324 but I could have re-deployed that capital and perhaps even made some or all of it back in the next 2 weeks. And it’s certainly easier to make up $325 than $1150.

So, hopefully, I’ve shown why a silly mantra of “Pets vs. Cattle” helped make me a better trader. I still say this to myself today whenever I’m tempted to break one of my guidelines. I put it in my trade notes when I close a trade early. This little phrase helps keep me from getting too attached to my trades. It reminds me to not get emotionally invested in my trades. Losses will happen and are ok as long as they are small losses. Maybe this can help you too.

As always, feel free to leave me feedback here on the site or reach out via email at midway@

Good Trading!