Charles Cottle and Ali Pashaei presented “Surviving and Thriving in Volatile Markets” on Friday. They showed how they navigated the large move down and did well protecting their portfolios.

Charles and Ali teach group mentoring classes at Aeromir.com. They are offering 15% to 30% discounts to their recorded classes but you have to act before midnight Eastern on Friday January 25, 2019.

To see what Charles and Ali have been teaching, please visit these pages:

To order discounted recorded classes, please click on this button:

Enjoy the replay!

]]>Charles Cottle and Ali Pashaei are presenting a free webinar of how to survive and thrive in volatile markets

The webinar will be Friday, 18 January 2019 at 11:00am Eastern.

>>> Register for the webinar <<<

The webinar should be approximately 60-minutes but may go over if there are enough questions.

The webinar will be recorded and posted on our YouTube channel. Consider subscribing to our YouTube channel to be notified when the recording is ready.

]]>Volatility levels are widely used by traders when making a decision to enter or exit a position. Understanding the differences between the various metrics of volatility can help gauge option pricing, and can be essential in your efforts to be more consistently profitable in your trading.

Implied Volatility Percentile (IVP) or Implied Volatility Rank (IVR) are two tools which can be used to track historical volatility. Using these tools will show you where the current IV number is in relationship to what volatility has been in the past.

When you learn to use the relationship of the current implied volatility and compare it to historical volatility by using either IV percentile (IVP) or IV rank (IVR), you will have an edge in your trading for many strategies. When you compare IV to IVP or IVR, it is important to use IVP consistently or IVR consistently. Comparing the current IV to both IVP and IVR can lead to confusion. It is important to either use IVP or IVR. Using IVP one time and IVR the next time is not recommended. Stay consistent.

When you look at the implied volatility (IV) of an option, it is reflecting the current IV. It is important to understand the relationship of the current volatility to the past historical volatility. This will help to determine what type of trading strategy to use when you enter a trade.

The can give your trading an edge.

To start, let's review the basics of Historical and Implied Volatility

**What is the definition of Volatility?**

**Historical Volatility**is a measure of past performance. Because it allows for a more long-term assessment of risk, historical volatility is widely used by traders and market analysts in the creation of investing strategies. Historical volatility is also referred to as realized or statistical volatility. For the purpose of this article, I am using current IV percentile as historical/statistical IV. IV Rank is another method to determine historical IV which you will also learn about in this article.**Implied Volatility (IV)**is the estimated volatility of a particular stock/index. IV is a calculation which reflects the current volatility. In general, implied volatility increases when the market is bearish, when investors believe that the underlying price will decline over time. Generally, implied volatility decreases in a bullish market, when investors believe the underlying price will rise over time. If there is a sharp move upward in price, there are instances when short term volatility may increase.

**How can Implied Volatility affect Options Traders?**

**Implied volatility is one of the key factors in the pricing of options.**Options give you the opportunity to purchase or sell an underlying at a specific price during a pre-determined period of time. The higher the implied volatility, the more premium the option will have. The less the implied volatility, the less the option's premium.**Knowing the relationship between implied volatility (IV) and current IV percentile**can allow you to determine if an option is more inexpensive or expensive…**Implied volatility has the biggest effect on the amount of extrinsic value in the price of an option.**When IV increases, the extrinsic value of both calls and puts increases. This makes the call and put option prices more expensive. When IV decreases, the extrinsic value of both calls and puts decreases. This makes the option prices less expensive. If you would like to read more about the intrinsic and extrinsic value of options, here is an article published on August 17, 2018: Intrinsic and Extrinsic Value of Options

**An option's value is determined by the following components:**

- Stock Price
- Strike Price
- Time to Expiration
- Volatility
- Interest Rates
- Dividends

Five of these components are easy to determine. They are basically fixed. The one which is unknown is volatility. As volatility goes up or down, it can reflect significant changes in the price of an option. Two of the most important components of an option's price are volatility and time to expiration. These two components can greatly affect your overall profit and loss. When you purchase an option, it is not enough to be right on market direction. You also have to be aware of time decay, volatility, and the relationship of current IV to its historical IV.

** What is IV Percentile?**

Implied Volatility Percentile (IVP) can provide traders with an additional metric to help gauge the pricing of options. IVP will tell you the percentage of days over the past year that implied volatility traded below the current level.

To explain IVP, let's start by looking at the current implied volatility using the S & P 500 Index as an example.

The one year chart of SPX is shown below, showing the current implied volatility of 21.67%.

Figure A. One Year SPX Chart indicating current Implied Volatility

Below is a screenshot taken from the Think or Swim option chain.

Figure B. Today's Options Statistics from Think or Swim

One way to find Current IV and IV percentile on the Think or Swim platform is to scroll down to the bottom of the option chain and look for Today's Options Statistics. It shows the Implied Volatility of 21.67%, as well as the Current IV percentile at 34%**. **

The current IV Percentile is calculated by taking the number of trading days the IV of SPX was below its current level and dividing it by 252 (the number of trading days in a year). The current IV Percentile in this example is 34%.

Using this example with IVP at 34%, the understanding can be that implied volatility of SPX traded below the current implied volatility of 21.67% for 34% of the past year, or about one-third of the year. This indicates that SPX IV was below 21.67% for about one third of the year. For two-thirds of the year, the implied volatility was above the current level of 21.67%.

This means that the current IV of SPX in relationship to its historical past is in the lower one third region. Therefore, option prices will be less expensive or “rich” than if the current implied volatility was at higher percentage.

**How do you know if the IV of an option is high or low in relationship to itself?**

**Here is an example:**

Stock ABC ‘s current price is currently trading at 50. The implied volatility of the stock is 20.0%, and the IV percentile is at 80%. Looking at an implied volatility of 20.0% you, would probably think the current IV was on the lower side.

Look at the Implied Volatilty Percentile. It is at 80%. What does this mean to you? It means over the past year 80% of the time ABC’s current IV was below 20.0%. This indicates ABC options are probably costly due to the current implied volatility of 20.0% relationship to the implied volatility percentile of 80.0%.

Remember, the current IV of 20.0% was lower 80% of the time over the last year. This shows the current IV to be high. This will make options more expensive or “rich”.

**Implied Volatility Rank is yet another volatility metric that many traders take into account when making their trading decisions…**

Implied Volatility Rank (IVR) can tell you whether the current implied volatility is high or low based on the IV over the past year. It is an average of the highest high and lowest low volatility for the past 52 weeks. Other time periods can be used such as 30 days with some trading platforms.

Let's use the same SPX example for one year to calculate IVR. The 52 week IV high was .468, and the 52 week IV low was .088. The formula used for a one-year IV rank is as follows:

Figure D. IV Rank Formula (photo courtesy of www.projectoption.com)

To calculate the one year IVR, look at the options statistics in Figure 2.

With SPX IV currently at 21.67%, the IV Rank would be calculated as follows:

Current IV (.2167) minus 1-Year IV Low (.088) = .1287

1-Year IV High (.468) minus 1-Year IV Low (.088) = .38

.1287 divided by .38 = IV Rank of .338 or 33.8%.

This IV Rank of 33.8% indicates that the current IV and the low IV is only 33.8% of the entire IV range over the past year. This means the current IV is closer to the low end of historical levels of implied volatility.

At the extreme levels, an IV rank of 0% means that the current IV is at the lowest point of the one-year range, and an IV rank of 100% means the current IV is at the highest point of the one-year range.

**How can you take advantage of the relationship between current Implied Volatility and IV Percentile or IV Rank?**

You can base the type of trade you place using Implied Volatility, IV Percentile and IV Rank. As you know, there are risks and rewards with every type of trade. A few strategies for consideration using high and low volatility levels are:

**High Volatility Could Indicate Opportunities to Sell**

You expect volatility to decrease, thus the option you sell could decrease in price, making it profitable.

**Credit spreads.**When you sell a credit spread, you will receive a higher credit when volatility is high.**Iron Condor.**When you sell an Iron Condor, you will also receive a higher credit when volatility is high.- When you buy a
**Butterfly**in a high volatility environment, your position will benefit as volatility drifts down, as long as the underlying price stays close to your short strike.

**Low Volatility Could Indicate Opportunities to Buy**

You expect volatility to rise, therefore, the option you buy could become worth more.

**Long put or put debit spread.**This trade can allow you to lower your cost and benefit from a spike in volatility.**Long Calendar spread.**This trade could benefit from the back month volatility increasing while the front month options decay.**Iron Condor.**The Iron Condor tends to perform better in higher volatility markets, but can still do well in lower volatility markets.

When you base your trade strategy on the relationships between Implied Volatility, and IV Percentile, and IV Rank, it does not guarantee that your trade will be profitable. However, it does give you a tool to use for your trade entries and exits so volatility can have a chance to work in your favor.

Do you have a trading method using volatility you would like to share? Please feel free to comment below.

]]>A calendar spread is a strategy often referred to as a time spread. A calendar is a method which could benefit from the time decay of an option and changes in implied volatility.

For the most part a calendar concentrates on the movement of time and volatility more than the movement of the underlying asset. For this reason a calendar spread can be used for either stagnant or large movements in the underlying.

Like any strategy the calendar has advantages as well as disadvantages. The risk can be quite limited for the buyer; the seller can have a larger risk. To contain some of the risk, a seller can act on the position at the expiration of the near term option. There are also strategies which can be used to lessen the seller’s risk.

One of the advantages of the calendar strategy is the position can be entered with less of an investment than purchasing the underlying asset.

**How is a Calendar Spread created?**

A Calendar spread is constructed by purchasing one option and the sale of another option in different expiration cycles in a one to one ratio. Both options will have the same strike price. The calendar can be created by using either two puts or two calls. The longer out in time option has more time value and will cost more than the closer in time option.

**How to construct a long Calendar…**

If you think the volatility is at a low level, you can buy a long calendar. To create a long calendar, you would purchase one option with an expiration further out in time and sell one option with expiration closer in time. As an example, you would buy a February 50 Call option and Sell a January 50 Call option. Another example, would be to buy February 50 Put option and sell a January 50 put option.

Figure A. Long Calendar Risk Graph from Think or Swim

As you can see in Figure A, the strike price of 50 is at the center of the risk graph. The highest profit potential is at the strike price.

**How you could profit from the long calendar spread…**

You can profit from a long calendar spread as time progresses and the price of the underlying stays favorable. The shorter term expiration will decay at a faster rate than the longer term position.

If the volatility increases the further out in time option will increase faster than the closer in time option. This will tend to increase the value of the calendar spread.

If you enter the calendar spread either in-the-money or out-of-the money and the price of the underlying moves towards the strike price, the position will gain in value.

**How you could lose from a long calendar spread… **

A decrease in implied volatility will decrease with the farther out in time option more quickly than it will decrease the value of the closer in time option. This will cause the position to lose value.

If the price of the underlying asset moves away from the calendar spread strike price, the calendar spread will decrease in value.

**How to construct a short Calendar Spread…**

If you have the assumption volatility is at high levels, you can create a short calendar. To create a short calendar, you would sell the farther out in time option and buy the nearer term option. For instance you would sell a February 50 Call option and buy a January 50 Call option.

Figure B. Short Calendar Risk Graph from Think or Swim

As shown in Figure B, the short calendar profits more as the underlying moves away from the center strike of 50.

*A word of caution concerning short calendar spreads. Shorting the longer dated option and buying the shorter dated option can be risky. The shorter dated option will expire before the longer dated option. This could lead to the seller of the longer dated option being naked that longer dated option. Therefore, the brokerage will most probably margin your account as though you are short the naked option. *

**How you could profit from a short calendar spread …**

If implied volatility decreases, the further out in time option which was sold will tend to lose money more quickly than the closer in time option which was bought. This is due to the higher Vega in the further out in time option. This will tend to create an increase in value to the seller of the calendar spread.

If the underlying asset moves up or down, away from the strike price of the calendar spread which was sold in either direction, it will tend to increase in value for the seller of the calendar spread, as long as the time decay of the option does not outdo the movement of the price of the underlying.

**How you could lose from a short calendar spread …**

As time passes it will usually negatively affect the seller of a calendar spread. This is due to the nearer term option, which is the long option for the seller, decaying at a more rapid pace than the farther out in time option, which the seller of the calendar spread is short.

If implied volatility increases it will also affect the seller of the calendar spread negatively. When the volatility increases the longer term option which was sold increases in value more quickly than nearer term option which the seller is long due to the longer term options higher vega.

**At-the-Money vs. Out-of-the-money and In-the-money options… **

Many times calendar spreads are entered at-the-money due to at-the-money options having the greatest amount of extrinsic value. The extrinsic value of an option will decay as the option gets closer and closer to expiration. This can be beneficial for a calendar spread because the strategy is looking for time decay.

There are other calendar strategies which can be constructed using out-of-the-money and in-the-money options. It is your choice.

The decay rate of the option with the same strike price, which has a longer expiration date will be slower to erode than the decay rate of the option which is closer to expiration. This applies to an in-the-money option, out-of-the money option or at-the-money option.

**Gamma’s Effect on the Calendar Spread…**

Gamma can be defined as the rate of change of the option’s delta as it relates to the movement in the price of the underlying. It can be thought of as the delta of the delta.

Gamma tends to be highest with at-the-money options in the nearer term expiration. Gamma will tend to decrease the further the price of the underlying moves away from the at-the-money strike and as the expiration date moves further out in time.

The nearer term option expiration will move more quickly due to its’ gamma being higher.

**How Does Volatility Influence a Calendar Spread?**

It is important to monitor the change in volatility when using the calendar spread strategy.

The volatility of an option is measured by vega. Vega is an approximate measurement of how much an options price will tend to change with a one point move in implied volatility.

Vega is shown in dollars for a one tick move or change in volatility. Let's say an option is valued at $2.00 and has 45 implied volatility with a vega of .05. Then the volatility moves up one tick to 46. The option would now have an approximate value of $2.10.

This is calculated by multiplying .05 times 2.00 which equals .10 or 10 cents. Adding the .10 to the original value of the option which was $2.00 equals $2.10.

**Key points about vega …**

- The price of an option will change as volatility increases or decreases
**Vega will tend to decrease with shorter dated expiration options**- Vega will tend to increase with longer dated expiration options
**Vega tends to be greatest with at-the-money options**- Vega applies to the strike price both calls and puts
**Vega will tend to increase when volatility increases**- Vega will tend to decrease as volatility decreases

**Wrapping up the Calendar Spread…. **

- Use two call options or two put options
**Use the identical strike price for both of the options**- Select different expiration periods for each option
**Create a one-to-one ratio**- Any two expiration periods can be used to create the calendar spread.

Usually, the calendar spread benefits when the price of the underlying is not moving too much and stays within a range.

If you have limited capital, the long calendar spread offers limited risk when entered as a debit. The risk is defined to the debit paid for the calendar.

You can use the calendar spread when volatility changes are expected.

As a seller of a calendar spread, you can take on potentially greater risk.

When the underlying price moves away from the calendar strike price, the buyer of a calendar will tend to lose money.

When the underlying price moves away from the calendar strike price, the seller of a calendar could increase profits as long as time decay does not surpass the movement of the underlying’s price.

If you have experience trading calendars, either long or short, and would like to share with the community, feel free to comment below.

Are you new to trading looking for mentoring, or an educational trade alert service? Or, are you a veteran seeking a trading group where you can interact with like-minded traders who share their experiences? Look no more. Join Aeromir today!

]]>Marko, from OptionSlam.com, is presenting the Double Eagle Trade on the Aeromir Round Table on Wednesday, 10 October 2018 at 11:00am Eastern.

The Double Eagle Trade is a pre-earnings trading discipline with an excellent track record. We know you'll enjoy the presentation.

Marko is teaching a workshop on the Double Eagle next weekend.

We look forward to seeing you on the webinar!

]]>Gamma, one of the options “Greeks”, is often referred to as the Delta of the Delta. Gamma is the rate of change in the delta of an option per a one-point move in the underlying instrument. It is important for traders to understand the effect Gamma can have on their positions. As Gamma increases, it can dramatically affect a position in terms of its profitability.

To define and provide an understanding of Gamma, we will first touch on Delta. Delta measures the price movement of an option with a $1.00 movement in the underlying. If an option has a .38 Delta and the underlying instrument moves $1.00, the option price theoretically would move $.38 in value. Thus, the new option price would theoretically be $1.38.

**What is long Gamma?
**

When you purchase an option, either a call or put, it creates long Gamma. If you are long Gamma and the underlying instrument increases in value, the Delta of the option strike will theoretically increase by the amount of your Gamma for every $1.00 move in the underlying instrument. If the underlying's price decreases, the Delta of the option strike would theoretically decrease by the amount of the Gamma for every $1.00 movement in the underlying. So, if the underlying's price increases and you are long Gamma, your Delta would theoretically increase. The opposite occurs if the underlying price decreases and you are long Gamma – your Delta would theoretically decrease.

**What is short Gamma?**

When an option is sold, you are short Gamma. When a position is short Gamma and the price of the underlying increases, the position Delta would decrease. Conversely, if a position is short Gamma and the price of the underlying decreases, the Delta of the position would increase.

**How Gamma and time are related…**

Time affects Gamma.

The closer an option gets to its expiration, the higher the Gamma. An option's Gamma is highest in the nearest term expiration cycles. Gamma is also highest for options at-the-money or near-the-money. As with many aspects of trading, there are exceptions to this which I'll discuss later on. Gamma tends to decrease as the underlying's price moves away from the at-the-money strike. As the price moves further in-the-money or further out-of-the-money, the Gamma tends to decrease.

Let's use Figures A and B below with SPY as an example to illustrate the affect time has on Gamma. Below are two option chains for SPY; 7 September which is 2 days until expiration, and 19 October which is 44 days until expiration.

SPY is currently trading at 289.64, so the 290.00 strike is at-the-money for the October 19 cycle, and the 289.50 strike is at-the-money for the 7 September cycle.

Figure A. SPY Put Option Chain 44 Days to Expiration, SPY currently trading at 289.64.

Figure B. SPY Put Option Chain 2 Days to Expiration, SPY currently trading at 289.64.

Refer to the Gamma column in Figures A and B to see how Gamma is affected by time. Also notice the relationship of Gamma at-the-money, and further out-of-the-money. Do you see how it tends to be higher at-the-money? Do you see how Gamma tends to decrease as it moves away from the at-the-money strikes?

**As I said earlier, there are exceptions to the effect of Gamma over time …
**

What are the exceptions? At times, the back period expirations can have higher Gamma than the near-term expirations. This may occur because options that are very deep-in-the-money act like the stock itself, and stock itself has no Gamma.

**It's important to understand how Gamma can affect a position which is composed of multiple options…
**

As shown in the SPY option chains in Figures A and B above, each option strike has it's own Gamma. Most trading platforms combine the Gamma for each option, and calculate the long and short Gamma to determine the overall Gamma of a position composed of multiple options.

Many traders manage their positions according to Gamma, and feel that Gamma can be a measure of how often a position may need adjusting. They do this by looking at the T + 0 line (the black, curved line in Figures C and D below) You can get a visual of Gamma on most platforms when you view a risk graph. Is the T + 0 line relatively flat or is it curved? If your T + 0 line is flat or only slightly curved, your position will have less Gamma. If it is steeply curved, your position will have higher Gamma.

Using SPY again, see the two Iron Butterfly positions in Figure C and D. We will use the same expiration cycles as in the option chain example above … September 7, which is 2 days to expiration, and 19 October which is 44 days to expiration.

Figure C. SPY Iron Butterfly 2 Days to Expiration (sharply curved T + 0 line)

Figure D. SPY Iron Butterfly 44 Days to Expiration (flatter T + 0 line)

The two positions shown above in Figure C and D are for an at-the-money Iron Butterfly, which consist of: Short the 290 call strike, long the 295 call strike; short the 290 put strike, and long the 285 put strike.

In Figure C, with only 2 days until expiration, the Gamma is -27.42, whereas the position Gamma in Figure D which has 44 days until expiration is only -.1.10. See how steep the curve is on the T + 0 line (black, curved line) in Figure C versus Figure D?

Those who trade shorter term positions such as weeklys take on the potential of a higher profit, as well as the risk of a larger loss on their positions with even the smallest move in the underlying. This is mainly because of Gamma. More conservative traders who trade longer-term positions such as the one in Figure D have less potential risk of a major profit or loss, at least early in the trade, due to the lower Gamma.

**Summing it up…**

It can be confusing at times, particularly for those traders with less experience, to remember the characteristics and relationships of an option's Gamma and Delta. An easy way to remember them is:

• Positive Gamma makes Delta more and more positive as the underlying price increases.

• Negative Gamma makes Delta more and more negative as the underlying price increases.

Gamma, like the other option Greeks – Delta, Theta, Vega, and Rho, is a metric that can be used to measure the level of risk for a position or portfolio. While Delta is often used as the Greek that affects a position's profit and loss as the underlying price moves, Gamma is a metric that a trader can use to gauge how much the Delta may move.

If you have any additional insights to Gamma and how you use it to manage your positions and would like to share, feel free to comment below.

Whether you are new to trading, or an experienced trader looking to fine-tune your craft, the Aeromir community is here to help you. There are trading groups where you can share your trades, educational trade alert services, mentoring, and more. Don't hesitate, join today!

]]>Because trends are composed of a series of price swings, momentum can play a key role in determining the strength of the trend. It is important to know when a trend may be slowing down, as it may be indicative of a reversal. How can a trader assess the strength of a trend? Using momentum, along with rate of change and momentum divergence, can signal something may be changing. This could mean that the trend may consolidate, or even reverse.

Price movement refers to the direction and magnitude of price. By comparing price swings, a trader may gain insight into price momentum.

**How is momentum defined?**

The magnitude of price movement is measured by the length of the short-term price swings. The beginning and end of each swing is established by price pivot points, which form swing highs and swing lows. Strong momentum is indicated by a steep slope and long price swing. Conversely, weak momentum is exhibited by a shallow slope and short price swing.

There are several momentum indicators such as the Relative Strength Index (RSI), Stochastics, and Rate of Change (ROC). The examples we will be using are analyzed with the Rate of Change Indicator.

Below is a six month chart of SPX with the Rate of Change Indicator.

Figure A. SPX 6 month chart with Rate of Change Indicator

As you can see in Figure A, for each upswing in price, there is a similar upswing in the Rate of Change (ROC). When price swings down, ROC also tends to swing down.

**What is the calculation for Rate of Change?
**

The default settings for Rate of Change calculation on Think or Swim as shown in Figure A above are:

• Length – the number of bars used to calculate the Rate of Change. Think or Swim uses 14-days as the default.

• Color norm length – the number of bars used to calculate the color gradient. In Figure A above, this is also 14-days. You can see the gradual change from red to blue as the price changes.

• Price – This is the price used in the calculation of Rate of Change

In Figure A above, the default setting on Think or Swim is the closing price. Traders have a choice of other prices such as open, high/low divided by 2, high/low divided by 3, volume, etc.

In the case of Figure A above with the default settings as outlined, the rate of change divides today's closing price by the closing price days 14 days prior. If both values are equal, ROC is 1. If today's price is higher, then ROC is greater than 1. Conversely, if today's price is lower, then ROC is less than 1.

Many traders find oscillators such as ROC are most useful using narrow time frames, detecting potential short-term changes in the market, perhaps within the time frame of a week. Other indicators that are trend-following are most often better used for longer-term trends.

**What Rate of Change means for traders …
**

In general, when ROC is rising, it indicates a bullish market and prices are likely to continue higher. When ROC is falling, the outlook becomes bearish and lower prices could be likely.

When prices rise but momentum or ROC falls, this is called momentum divergence, which we will discuss next.

**What is divergence?
**

Divergence is usually associated with an oscillator indicator. For the purpose of this discussion, we will continue to use the Rate of Change indicator. Many traders use divergence to aid in their decisions for new trade entry, adjustments, or exit.

Divergence in technical analysis can occur when the price of an underlying and an indicator are moving in the opposite direction of each other on a price chart.

• Bullish divergence occurs when the underlying price is moving lower as the indicator moves higher.

• Bearish divergence occurs when the underlying price reaches a new high, as the indicator moves lower.

Either bullish or bearish divergence may be a signal of a shift in the direction of the price of the underlying.

You can see an example of both bullish and bearish divergence on the charts below:

Figure B. Bullish Divergence chart from Think or Swim

Figure C. Bearish Divergence chart from Think or Swim

**How can traders interpret divergence?**

Bullish, or positive, divergence can be a signal the downtrend may be weakening. Traders may interpret the lower lows in price while Rate of Change makes higher lows to be an indication a rally is forthcoming. This may be a signal to go long and enter a bullish position.

Bearish, or negative, divergence could be a signal the uptrend may be weakening. Traders may interpret the higher lows in price, while Rate of Change makes lower lows, to be an indication a downtrend may be forthcoming. This may be a signal to go short and enter a bearish position.

**In conclusion …
**

The momentum indicators can be powerful indicators that can guide the trader on not only the market's future direction, but also the speed of the direction. It is important to note that there must be price swings of sufficient strength to make momentum analysis valid. When the market is in a strong trend in either direction, oscillators tend to not function all that well.

Momentum divergence can indicate that something is changing, but it does not mean the trend will always reverse. It is a signal a trader could consider to make modifications to his/her strategy…trade entry, adjustment, and/or exit.

Those using the Rate of Change or other momentum indicators should do so in conjunction with other technical analysis such as price action, support and resistance, volume, etc. Also, any one indicator a trader chooses to incorporate into his/her technical analysis is not going to make you money unless you use it consistently.

If you have found the momentum indicators to be particularly helpful in your technical analysis and would like to share, please comment below.

Whether you are new to trading, or an experienced trader looking to fine-tune your craft, the Aeromir trading community is here to help you. Don't hesitate. Join today!

They have a wide variety of programs including mentoring, educational trade alert services, trading groups, and veteran traders willing to share their trade techniques. When you surround yourself with consistently profitable traders, your own trading can improve.

]]>Intrinsic and extrinsic option values are two components of an option chain which can be very important to an options trader. Knowing the intrinsic and extrinsic option values can help you as an options trader choose a good option candidate with its’ corresponding strike price and expiration. This can be a key factor in laying a foundation for you. This can help to give you an edge in your trading.

If you are new to options trading, please be patient – it takes time to become familiar with the terminology associated with options. It is time well spent for you and your success on becoming a consistently profitable trader.

To start, let’s look at the option chain. An option chain shows all the puts, calls, and the strike prices with each corresponding option price for an underlying asset with its’ expiration date. Below is an option chain of PYPL, showing the current trading price of the underlying, as well as the Bid and Ask prices of each strike price. These are two important components to determine the intrinsic and extrinsic option values of the option.

Most trading platforms allow you to see the intrinsic and extrinsic value of each strike price, so it is not necessary to perform the calculations. However, for those who may be new to trading, I will cover several examples, going through the calculations of the intrinsic and extrinsic value of various strike prices.

Figure A. PYPL 21 SEPT 18 Option Chain

**What is the Intrinsic Option Value?**

To get an understanding of the meaning of the word intrinsic, let’s explore the definition. According to Merriam-Webster, intrinsic is defined as “belonging to the essential nature or constitution of a thing”. According to the Cambridge English Dictionary, intrinsic is defined as “being an extremely important and basic characteristic of a person or thing”.

*The Intrinsic Value of a call option is the price the underlying is currently trading minus the strike price. If the value which is calculated is a negative number, then the intrinsic value is zero.*

**Calculating the Intrinsic Value of a Call Option
**

Let’s use the PYPL option chain which is shown above to determine the Intrinsic Value of the 80 Strike Call Option. PYPL’s last trading price was 86.72. Take the last trading price (86.72), and subtract the 80 Strike, which equals 6.72. Therefore, 6.72 is the intrinsic value of 80 Strike Call Option. It also means the 80 Strike Call Option is 6.72 In-The-Money.

Now let’s calculate the intrinsic value of the 90 Strike Call Option. PYPL's last trading price was 86.72. Take the last trading price (86.72) minus the 90 Strike, which results in negative -3.28. Since the result is a negative number, there is zero intrinsic value in the 90 Strike Call Option. It is currently Out-Of-The- Money, therefore, it does not have any intrinsic value.

**Calculating the Intrinsic Value of a Put Option
**

As an example in Figure A, take the 90 strike put option minus the last trading price (86.72) which equals the intrinsic value of 3.28. The 90-strike put option is 3.28 In-The-Money.

Now calculate the intrinsic value of the 80 strike put option. Take 80 minus the last trading price (86.72) which equals a negative -6.72. Since the intrinsic value is a negative number this means the intrinsic value is zero. The option is 6.72 Out-Of-The-Money.

**What is the Extrinsic Option Value?
**

The definition of extrinsic, according to Merriam-Webster, is “not forming part of or belonging to a thing “extraneous”. According to the Oxford Dictionary, extrinsic is defined as ”not part of the essential nature of someone or something; coming or operating from outside”.

Have you heard the saying “time is money”? “Time is money” applies to the extrinsic value an option. If you have a liability, you want to be paid for carrying that liability. Therefore, one of the costs of carrying that liability is the time value or extrinsic value of that option.

The extrinsic value of an option is many times referred to as “the time value”. The time value is one of the primary elements which affects the premium of an option.

An option contract will usually lose value as it approaches its’ expiration date. As a rule, an option that is currently trading Out-Of-The-Money, with 30 days left until expiration, will have more extrinsic value or time value, than an out-of-the-money option with 7 days until expiration. The reason for this is, there is more time left in the 30 days till expiration option than the 7 days to expiration option. Since there is more time remaining in the 30 day option, it has more extrinsic value.

Implied volatility also affects the extrinsic value of an option. Implied volatility is the degree that an underlying asset could move over a certain amount of time based on the current market prices. Implied volatility is only an estimate. If the implied volatility increases, the extrinsic value will rise. If implied volatility goes down, the extrinsic value of the option will also decrease.

In-The-Money-Options can have both Intrinsic and Extrinsic Values. Out-Of-The-Money options only have extrinsic value.

**Calculating the Extrinsic Value of an Option**

To determine the extrinsic value of an option for both the calls and the puts, use this formula:

*Current option price minus the Intrinsic value = Extrinsic Value.
*

Let’s use the example of the PYPL 80 Strike Call Option which was calculated above to have an intrinsic value of 6.72. To calculate an approximation of the current option price of PYPL 80 Strike Call Option, let’s use the option chain in Figure A. The bid price is 7.50 and the ask price is 7.65, so the average of the two prices is 7.57. This is the approximate option price. Now, take the option price (7.57) minus the intrinsic value (6.72) which equals an extrinsic value of 0.85.

Now let’s calculate the extrinsic value of the 90 Strike Call Option. The bid price of the 90 Strike Call Option is 1.42 and the ask price is 1.46. The average price of the bid/ask is 1.44. The intrinsic value was calculated above to be zero. Now, take the option price 1.44 minus the intrinsic value zero which equals an extrinsic value of 1.44.

PYPL has a current price of 86.72. Therefore, the 90 Strike Call Option is Out-Of-The-Money. The value of the option is made up solely of its’ extrinsic value.

**Calculating the Extrinsic Value of a Put Option
**

Let’s use the example of the PYPL 80 Strike Put Option which was calculated above to have an intrinsic value of zero. To calculate an approximation of the current option price of the PYPL 80 Strike Put Option, let’s continue to use the option chain in Figure A. The bid price is .63 and the ask price is .66. The average of the two prices is .65, which is the approximate option price. Now, take the option price (.65) minus the intrinsic value which is zero, which equals an extrinsic value of .65. PYPL is currently trading at 86.72, so the value of the 80-strike put option is made up entirely of its extrinsic value.

Now let’s calculate the extrinsic value of the 90 Strike Put Option. The bid price of the 90 Strike Put Option is 4.35 and the ask price is 4.60. Therefore, the average price of the bid/ask is about 4.48. The intrinsic value was calculated above to be 3.28. Now, take the option price (4.48) minus the intrinsic value (3.28) which equals an extrinsic value of 1.20.

**Summing it up…
**

Intrinsic and extrinsic option values can help a trader to determine which option or options could help increase the probability of a profitable position. In-The-Money options can have intrinsic and extrinsic value. An In-The-Money option can be exercised. Out-Of-The-Money options only have extrinsic value and cannot be exercised.

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]]>The value of the SKEW Index rises with the tail risk of the S & P 500 Index. When there is no tail risk, SKEW is equal to 100. When SKEW is close to 100, probabilities of a sharp market move remains small. As the probability of a major market move increases, the SKEW index rises.

The mathematical definition of “standard deviation” is a measure of the dispersion of a set of data from its mean. The more the data is spread apart, the higher the deviation.

These standard deviations are important to options traders because they give definitive metrics which can be used to gauge the probability of a successful trade. Of course, there is no indication of the direction of a potential move; you as a trader can use your own technical expertise and chart analysis in conjunction with the standard deviation metrics. It is also worth mentioning that no trade can have a 100% probability of success. Even trades with boundaries of profitability of three standard deviations have the small but real probability of moving outside the predicted range of movement.

Represented by a bell curve, the graph below illustrates standard deviation and a normal distribution curve:

Figure A. Normal Distribution Graph (Image courtesy of Wikipedia.org)

If the data points in the distribution graph are all near the mean (center of the graph), then the standard deviation is close to zero. The farther away the data points are from the mean, the higher the standard deviation. The bell curve in Figure A is a normal distribution, and demonstrates that among a certain number of samples, there is normal outcome. In options trading, these normal outcomes can be used as a tool.

Breaking this outcome into percentages:

• +1/-1 standard deviation covers 68.2% of occurrences

• +2/-2 standard deviation covers 95.4% of occurrences

• +3/-3 standard deviation covers 99.6% of occurrences

Now, compare the normal distribution graph to ones that are skewed (to the left or the right). The chart below illustrates a normal distribution graph, as well as skewed graphs.

Figure B. Distribution Curves (image courtesy of assetinsights.net)

In Figure B, the Positive Skewness (curve on left) has a longer tail to the right, which indicates more tendency of upside risk. The Negative Skewness (curve on right) has a longer tail to the left, which indicates more tendency of downside risk.

**How is the SKEW Index calculated?
**

SKEW is calculated from the prices of S & P 500 options using a similar type of algorithm as that which is used to calculate the VIX, which is the CBOE Volatility Index. The mathematical calculation of SKEW can be found here: SKEW Index calculation

The SKEW Index typically ranges from 100 to 150, with a historical average of approximately 115. The higher the SKEW index rating, the higher the perceived tail risk and chance of a significant move.

Below is a 3 year, weekly chart of the SKEW Index from Think or Swim

Figure C. 3 year weekly SKEW Chart

The 20 period moving average is showing a value of 138.45 in Figure C above. The current SKEW value is 144.49. Since the SKEW's historical average value is approximately 115, the current SKEW of 144.49 is higher than normal. A trader who is fearful of increasing volatility may want to be cautious.

**How can traders interpret the SKEW Index?
**

While the SKEW index itself cannot be traded, investors may use it to help determining market risk. In general, the SKEW index rises to higher levels as investors become more fearful of a major, unexpected selloff of a large magnitude – a “black swan” event.

As the slope of implied volatility rises, the SKEW Index tends to rise. This may indicate an increase in the probabilities that a major market-moving event is forthcoming. It doesn’t, however, necessarily mean it will happen.

By monitoring the SKEW as it increases over 100, traders may choose to hedge their portfolios, add to current hedges, etc. As with any technical indicator, the SKEW index should be used in conjunction with other technical analysis such as support and resistance, volume, etc.

**Is the SKEW Index related to the VIX?**

The SKEW and VIX indexes are different from each other; yet complementary in terms of measuring the risk of the returns of the S & P 500 over a 30-day period. The VIX is a fairly close representation of the standard deviation of those returns, but this sometimes is not enough to measure the true risk because over time the distribution of the S & P 500 returns exceeds one standard deviation.

The SKEW index describes the tail risk of the distribution; it is a measure of the S & P 500 returns that are greater than two or three standard deviations below (or above) the mean.

Below is a one year daily chart, showing both VIX and SKEW.

Figure D. VIX/SKEW 1 year Daily Chart

Figure D above shows the correlation of SKEW and the VIX. From late December through the middle of January the VIX was hovering around 10 (right axis). At the same time, the SKEW index was in the 120’s to 130’s (black line/left axis). During this period, SPX was continuing to move up in price, as you can see in Figure E below. A trader could interpret this to be an indication of a possible large move in price because SKEW was in the 120 to 130 range. The VIX reached a high of 50.3 on February 6th 2018; at the same time SKEW was around 133.

As with any indicator, signals can be tricky. As an example, please take note of the low price of SKEW (117.99) on January 26, 2018. At the same time the VIX was trading around 10. The SKEW had moved down to 117.99 from its’ previous higher levels, indicating less of a risk of a major market move. This occurred just before the price of SPX started to decline dramatically. A trader may interpret this as a mixed signal.

Figure E. SPX 1 Year Daily Chart

Here’s a good video to watch by Alessio Rastani, which shows other scenarios of the SPX/VIX/SKEW correlation, to forecast a potential large move in the market.

Go to…How to Predict a Fall in the Stock Market

**In summary …
**

A trader cannot use the SKEW Index itself as an instrument to place a trade. What it can do for traders is to measure current market risk. The SKEW index for the most part ranges from 100 to 150. The SKEW Index usually rises in market uncertainty.

The SKEW Index is one more tool for traders to have available to them to make a more informed decision on their positions and portfolio.

Any one indicator you as a trader choose to incorporate into your technical analysis is not going to make you money unless you use it consistently, and this holds true for the SKEW index.

Following the SKEW index along with its relationship to the VIX, as well as price action, may give traders an insight on overall market risk.

If you have found that monitoring the SKEW index has been helpful in your trading and would like to share, feel free to comment below.

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]]>Exchange Traded Funds (ETFs) are funds that track indexes such as the S&P 500, Nasdaq 100, Dow Jones Industrial Average, Russell 2000, etc. When an investor buys shares of an ETF, they are actually buying shares of a portfolio that tracks the yield and return of the related index. By purchasing an ETF, investors get the diversification of an index fund, but at a much lower cost. Some ETF shareholders are also entitled to a portion of the profits, usually paid quarterly, in the form of dividends. The use of ETFs is a popular choice among traders.

Today we will talk about a family member of the traditional ETF, Inverse ETFs. We'll cover just what inverse ETFs are all about, and how traders may use them in their trading.

Similar to traditional ETFs, Inverse ETFs also track indexes such as the S & P 500, Nasdaq 100, etc., but they are comprised of multiple derivatives designed to benefit (profit) from a decline in the value of the underlying benchmark. This is the opposite of traditional ETF's. Inverse ETF's are also referred to as a “Bear ETF”, or “Short ETF”. Inverse ETF's are mainly used by traders that either day trade, or hold onto the position for only a few days. Some traders use them as a short-term portfolio hedge, others who day trade may take a speculative trade on an Inverse ETF if they anticipate the underlying to decline.

There are many Inverse ETFs available to traders. A list of all Inverse ETFs currently available in the USA can be found here: Inverse ETFs

Today we will look at some Inverse ETFs that track the four major indices. Below are one year charts of the S & P 500, Russell 2000, Nasdaq 100, and Dow Jones Industrial Average indices. Overlaid on each chart is the corresponding Inverse ETF chart that correlates with the index.

**Figure A**. One year chart of the S & P 500 and the Inverse ETF SH

**Figure B**. One year chart of the Russell 2000 and the Inverse ETF TWM

**Figure C**. One year chart of Nasdaq 100 and the Inverse ETF PSQ

**Figure D**. One year chart of the Dow Jones 100 Industrial Average and the Inverse ETF DOG

You can see how price movement of the Inverse ETF (blue line) in each of the above charts has been in the opposite direction of the index itself (red and green line).

- Inverse ETFs can be used as an alternative to short selling, i.e. selling a call, to hedge a portfolio against downside risk . Because they are purchased, a margin account is not required. This can be a benefit for those who trade in Individual Retirement Accounts, where there are restrictions on taking a short position. Inverse ETF's allow any trader with a brokerage account to hold a short position if they feel the underlying will go down and they want to hedge their portfolio. For example, if a trader feels that the Nasdaq 100 will decline, he/she could simply buy shares of PSQ, or open an option trade on the Inverse ETF PSQ.
- Your risk is limited when purchasing an Inverse ETF. When you short an underlying, the losses could be significant if the market moves against you. With an Inverse ETF, your exposure is limited to the cost of the ETF or option.
- It is also possible for a trader to purchase an Inverse ETF on a specific sector, such as financials, energy, or technology. If an investor is bearish on any one of these sectors, they may want to purchase the Inverse ETF for which that sector is associated.

- Inverse ETFs are best suited for those traders looking for a short term hedge, not as a longer-term investment. The reason is that many Inverse ETFs utilize daily futures contracts as a basis for their returns, which can fluctuate dramatically in price from day to day. Because of these potential wild swings, pricing is not always accurately representative of the index they correlate with when held longer than a day. Day traders may find Inverse ETFs a very effective addition to their trading plan.
- Open interest can be low on some of the options for the Inverse ETF's, which means it may be difficult getting filled at the price desired. This low open interest will most likely create a wide bid/ask spread, which could potentially create lower profits along with greater losses than anticipated.
- Some, but not all, Inverse ETFs are leveraged, which can act as a double edged sword.

**What is leverage?** *“**Leveraged** investing** is a technique that seeks higher investment profits by using borrowed money. These profits come from the difference between the investment returns on the borrowed capital and the cost of the associated interest. Leveraged investing exposes an investor to higher risk”* according to Investopedia.com.

Let's say you purchased an Inverse ETF which is leveraged at 2x for a cost of $100, and it ends up at the end of the day at $110. The profit would be 10% for the day. Because the Inverse ETF is leveraged, you would realize a 2x profit of 20%. This can work the same way if the position goes against you. Let's say that this same Inverse ETF position goes against you the next day, and the value falls from $110 to $100, a loss for the day of 9%. The trader realizes a 2x loss on of 18%.

While this may not be that harmful on a small position, those losses can be significant depending on the size of the position. If the ETF you are considering is leveraged at 3x, it would mean that the profits AND losses would be three times greater than if there was no leverage.

In conclusion, investing in Inverse ETFs can be a useful tool for some traders. It may be worth considering the use of Inverse ETFs in your trade plan. It is wise have a full understanding of all the benefits – and risks involved. Be sure to know whether the Inverse ETF you are considering is leveraged, and to what extent, etc. Knowing all the risks involved in trading Inverse ETFs, as with any investment product, can help you make informed decisions on your trading.

If you have any experience on how you have used Inverse ETFs in your trading and would like to share, feel free to comment below.

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