Option Volatility and Pricing - Natenberg

Ch1

• Options futures are settled like stock, so they are unrealized gains / losses until position closes.  This is in contrast to futures, which are settled at the eod where all gains / losses are realized and deposited into each person's acct.
• Modelling 
• Time to expiration
• For volatility purposes we're only interested in trading days
• For interest rate purposes we must include every day
• Price of Underlying
• Use the price which will establish a hedge in the underlying. 
• Sell calls / buy puts use the ask
• Buy calls / sell puts use the bid (long delta offset against short delta)
• Interest Rates
• With stock type settlement - higher interest rate lowers value of option
• Higher interest raises stock price, but also increase carrying cost, which lowers value of option
• If you have 60 days until expiration, use 60 day t bill, find the appropriate t-bill that matches the option expiration
• Dividends
• If dividend is delayed, call options increase in value, puts decrease
• Volatility
• Daily STD - 256 trading days / year, so divide annual volatility by 16 to get the 1std of daily returns.  Ie: if 20% volatility, one would expect < 1.25% or less daily price change 2 / 3 days, and < 2.5% 19/20 days (2 std)
• Weekly STD - 52 weeks / year, so divide by 7.2.  20%/7.2  = < 2.75% for every 2/3 weeks
• Option Characteristics
• Delta is also approximately the % that option will finish in the money.  It's also the hedge ratio against the underlying
• For contracts w/ longer expiration the ATM 50 delta option will not always be the one closest to the current price, but the price * interest rate
• Gamma is directional risk
• ATM have highest gamma
• Theta is time decay
• gamma and theta have opposite signs and are negatively correlated.  the market will either move (gamma) or stay still (theta)
• Vega of all options decline as expiration approaches, so long term options are always more sensitive to vega than short term
• These greeks help you identify risks to make good decisions, not remove risk.  A trader that over analyzes these greeks will suffer analysis through paralysis and will be unable to make money.  The point is to find out which risks are acceptable and which are not.
• Spreads
• Volatility spreads should be constructed so that they are almost delta neutral
• these are concerned primarily with the magnitude of movement in the underlying, not the direction
• volatility consideration should always be more important than delta consideration, if not, the trade is not a volatility spread
• Spreads which are helped by movement in the underlying have positive gamma, and hurt by movement have negative gamma
• positive gamma is said to be long premium and hoping for a volatile market with large moves in the underlying
• negative gamma  is short premium
• any positive gamma trade will have a negative theta, and vice versa
• Spreads helped by rise in volatility have positive vega
• Every volatility spread can be placed in 4 categories

Category	Gamma	Vega
Backspread	Positive	Positive
Ratio Vertical Spread	Negative	Negative
Long Time Spread	Negative	Positive
Short Time Spread	Positive	Negative

• if IV is high, look for spreads with negative vega, if IV is low look for spreads with positive vega
• long time spreads are likely to be profitable when IV is low but expected to rise, short time spreads is opposite
• Adjustments
• adjust at regular intervals - adjust based on your volatility estimate, ie: daily volatility estimate, require daily adjustments
• adjust at predetermined delta - if you're willing to take directional risk, allow for delta up to a certain point
• adjust by feel - if the position's gamma will put you at a certain level of delta at a particular price level(positive delta at support), and you're correct, you will have saved yourself an unprofitable adjustment
• Risk Adjustments - which risks are you comfortable with?
• Theoretical Edge is what you determine to be the correct value for the option greeks.
• Delta Risk - risk that underlying will move in one direction over the other
• neutral position doesn't eliminate all risk, but it is immune to directional risk in a limited range
• Gamma Risk - risk of a large move in the underlying.  
• negative gamma position can quickly lose its theoretical edge with a large move in the underlying contract.  the consequence of this move must always be evaluated when analyzing each position
• Theta Risk -risk that time passes w/ no movment. 
• if you have positive gamma, how long can you wait before the theoretical edge disappears.  If the movement fails to appear in 1 day, 1 week, ect...does that negate the edge?
• Vega Risk - risk that volatility entered into model is incorrect
• vega is a risk present in every position, how much can volatility move before the potential profit from a position disappears
• Rho risk - risk that interest rate changes over the life of the option

Options For beginners and Beyond
Ch4 Greeks

• Delta - amount options moves from $1 move in underlying
• Gamma - amount delta changes for $1 move in underlying
• Theta - time decay of options in $
• Vega - amount option price moves for a 1 unit (ie: 1%) change in implied volatility
• Rho - amount option changes based on 1 unit(ie: 1%) change interest rate

Ch 9

• Trade with the trend.  Make sure stock has resumed its trend before entering again

Ch14 Volatility

• No matter how much the underlying moves, volatility always fluctuated from 5% to 20% for deutschemarks over a 10 year period, w/ an equilibrium of 11%
• Volatility Cone plots volatility over an X day period showing graphing the high and low as std during those periods
• Volatility of consecutive periods (ie: 15% 4weeks) tends to be correlated with the next 4 week period (next 4 weeks will be close to 15%)
• How to forecast
• What is long term volatility of underlying?
• What is the recent historical volatility in relation to mean volatility?
• What is the recent trend in historical volatility?
• Where is IV and what is it's trend?
• Are we dealing w/ short or long term options?
• How stable does the volatility tend to be?
• ie: 10 weeks to expiration => look at 50d (10w) historical volatility (20.6%), it is higher than long term mean (18.6%).  IV is declining and at (22.1%) => short volatility position makes sense
• if volatility cone shows that 10% HV is common range, a less risk strategy should be chosen
• Short term contracts are more likely to have larger swings in their IV compared to longer term contracts.  When IV contracts or expands, it is more noticeable in the short term contracts
• 
  

Option Strategies

• Debit spreads 
• are medium to long term trades
• you want to use options with expiration months that allow enough time for this move to occur
• Credit Spreads
• typically short term where you want to capture the credit as soon as reasonable possibly
• Conditions of a good credit spread
• Extra premium has been pumped into the side being sold
• Underlying stock needs little or no movement to achieve maximum profit
• both of the above achieved with front month options
• Look for 1 time events but wait until dust settles and premium still higher than before,  then initiate spread with short leg near the price extreme => look for roughly equal reward to max risk
• early Feb, RMBS, royalty fees, big drop, price stabilized at support, sell mar 22.5 / buy mar 25, for 1.25 credit and 1.25 risk
• early Feb DIS, hostile takeover by comcast for $27, price shot up to $28, then stabilized at $27 2 days later, it would be rejected unless comcast raised offer.  Sell Mar 27.5 / buy 30, 1.3 credit  / 1.20 max loss
• Mid apr, fell after good eps on high volume to $34 before stabilizing.  May Sell 35 / buy 32.50, credit 1.2 / 1.2 max loss
• avoid situations where it will be a continuing saga, as in accounting irregularities or possible restatement of earnings
• Put IV is higher lower in the chain, so makes bull put spreads less lucrative
• Calendar Spreads
• good for stable stocks that will move less than 15% over a month
• primary feature of calendars is to roll a new option every month for the front month short leg
• at least 1 month expiration difference so you can roll once
• use calls for expected upward drift, puts for expected downward drift
• exit the trade if you're taking a 50% loss, roll or close if you've achieved 50% of the gain
• IV is the most important characteristic of calendar spreads
• volatility skew - short option IV is larger than long option IV
• % increase in IV of short option compared to that of the long option
• 10% - 25% is ideal range, avoid IV skews > 30% esp when both have high IV
• early may XYZ is $17.  $17.50 Jun IV is 49, Jan IV is 41 = (49/41)  = 19.5% skew.  Buy Jan 17.5 for $2.10, sell Jun 17.5 for $1.15,$125 max gain /  max risk is $95
• Deep ITM Put Calendars - Expect stock to rise over time
• Buy 1 Leap (21 - 24months) w/ strike well above current price and sell nearer term Leap(9 to 12months) with same strike
• Both will be nearly the same price, thus making the cost low and offer substantial leverage.  As near month expires worthless, you can close immediately for max profit
• if all time values disappears and open interest is low, you might get assigned.
• sell the stock assigned to you and resell the same put option simultaneously, as 1 transaction.  
• Diagonal Spreads
• works best when the 2 strikes are no more than $2.50 apart because it keeps the maximum risk on the trade at a reasonable level, which restricts this trade to low / medium priced stocks, or indices
• Covered Call
• Focus on the stock price, and to a much lesser extent the option price.  Decide on an appropriate stop loss for the stock, and protect if it goes below by closing the option and stock
• Decide on the strike price at  a level where you are actually willing to sell the stock
• Choose 1 or 2 months out, do not go too far
• If you're going to get assigned, just accept the loss, don't buy back the call for a loss
• Straddles/Strangle - long call / long put
• Price between $20 - $50, if cheaper than $20, might not be enough room to fall, if above $50 options may be too expensive to create a straddle with good profit potential
• Identify an event.  EPS, court decision, FDA rulings
• Event is 30 to 60 days away.  Options do not expire until at least 30 days after the event.  So you're looking at least 60 to 90 days until expiration
• Upcoming event should not have already generated interest, open interest / trading volume should be normal.  IV vs HV should also be normal
• Look for a stock within a narrow trading range.  When it does breakout the option price will gain extra time value
• Exiting:
• Sometimes better to exit 1 side before the event.
• Don't stay in the straddle much longer after the event, sell the profitable option before time value decreases
• Never hold both sides of straddle until expiration.  Exit with 3 to 4 weeks before expiration
• Stock Repair
• buy 1 ATM call for each 100 shares, then sell 2 OTM calls
• only works if stock price rebounds
• example: stock declines from $35 to $23 by March
• L Jun 25 C for $3.30 / S 2 Jun 30 C for 1.75 => credit of $.20
• this creates a covered call w/ a bull call spread
• if stock closes at $30 by expiration you will have made $35
• to open for a credit, you need about 2 months until expiration
• Stock enhancement
• buy 100 shares at $58, holding for $75 target, starting in Mar
• L Jan 70 C for $3.70, S 2 Jan 75 C for $2.50 => credit of $1.30
• if stock is above $75, you will have generated equivalent of $81
• you can do also replace stock above w/ 1 Jan 40 call, for $19.70
• Collar
• stocks you intend to hold minimum 10 months
• example: nov 2004, you buy XYZ at $19 and plan to hold at least 1 year
• Buy 1 Jan 20 put for $2.90, Sell 1 Jan 25 call for $1
• max loss is $90(-4.3%), max gain is 17%
• enhanced if stock pays dividend
• if at a loss, it is possible to close early, however max gain you must wait until expiration
• used on conservative, non-volatile stocks
• Synthetic
• Long Stock - L 1 ATM Call, and S 1 ATM Put
• S Deep ITM Put will have delta close to +1, and substitute as L stock
• slightly higher probability of early assignment than call, because less time value
• S Deep ITM Call will have delta close to -1, and substitute as S stock
• BackSpreads
• only used when stock will move big, a small move generates a maximum loss
• example: in Feb XYZ is at $19, and you think it can go to $35 in the next year
• L 2 Jan 22.5 C $1.70, sell 1 Jan 20 call at $2.80.  Cost $60, max risk $310
• Butterfly
• focuses on a narrow range of profitability, but used when price is trending towards a target
• Ex: July, XYZ trading for $30, setup butterfly at $35 w/ 1 L Nov 30 P .80 / 2 S Nov 35 P $4.60, max profit at $35
• Adjustments can be made to take off the profitable S middle leg and leave on the L outer legs for a subsequent move in the opposite direction
• if price went up to $38 by late sept, you could sell the Nov 35 puts for $1, and collect $3.60 then hold the puts for a move down
• Iron Condor
• Use options that expire in 1 - 2 months
• No need to let trade get to worst case scenario
• Ex: Late December stock trading for $56, open 60 / 65, 40 / 45 iron condor, for $185, max loss $500
• if stock falls below 48 or above 62, close the trade for $100 loss.
• Double Diagonal
• You can roll the short legs once in this set to create additional profit
• No need to let trade get to worst case scenario
• Ex:Late December stock trading for $56, open Feb 60 / March 65, 40March  / 45 Feb double diagonal, for $150 profit, max loss $400
• if stock is below $48 or above $63 close for a $100 loss
• if price moves up to $60 or down to $50, the short feb options can be rolled to march options
• or feb 60 calls can be rolled up to 65, or feb 50 puts can be rolled down to feb 45 puts to create calendar spreads
• Vertical Spreads - used mainly for directional trades
• A vertical spread will always maintain its delta position, any time you buy the lower strike and sell the higher strike, you create a bullish (positive delta position). 
• The greater the distance, the greater the delta
• If IV is too low, vertical spreads should focus on purchasing the at the money option
• if IV is too high, vertical spreads should focus on selling the at the money option
• The focus is mainly on the at the money option to buy / sell when the volatility is mispriced.  You can trade the OTM or ITM first, and then leg into the ATM portion (closest to 50 delta)
• Conversions / Reversals
• create syntheic long or short, and then go short or long the underlying
• Boxes
• Synthetic L lower and Synthetic S higher, at expiration it will be worth the difference of strike prices.  This entire box will be discounted according to the interest rate
• 
  

Strategies by type

• Neutral w/ Bearish Volatility
• Covered call
• Butterfly
• Condor
• Double Diagonal
• Collar
• Neutral w/ Bullish Volatility
• Straddle / Strangle
• Calendar
• Bearish
• Bear Call Spread (credit)
• Put Backspread
• Bullish
• Bull Put Spread(credit)
• Call Backspread

Risk To Reward

• Come up with graphs using a computer 
• Use the risk of greatest concern
• if volatility is the greatest concern choose vega
• position vega / theoretical price (price i believe options are worth) and compare the different strategies
• large move? look at delta
• if gamma is positive, don't need to include

Adjustments

• new traders should avoid adjustments which increase the size of their position
• if you want to remain risk neutral, buy or sell the underlying contract to adjust the delta of the position
• if you use options, the remaining greeks will all also be adjusted, use them to get risk back to where you believe it should be while increasing your theoretical edge

Graphing

• x is price axis, y is profit axis
• Theoretical edge - After you input what you believe to be the correct volatility, the current price should have a positive PNL 
• Delta - at the current price, a positive delta will cross the current price w/ an upward slope
• the magnitude of the slope is the magnitude of the delta.  a delta neutral position will be flat across the current price
• Gamma - positive gamma will begin to bend upward as the price moves away from the current price in either direction, it will look convex like a smile
• Extreme moves - if the angle up or down at the edges of an extreme move are infinite, it acts like a naked position.  If it flattens out there are equal numbers
• Theta - as time passes positive theta will shift the graph up, while negative theta shifts down
• Positive Vega - as time passes positive vega shifts graph up while, negative shifts graph down

 Specifically, anyone who engaged in the simple "even" strategy of buying the stocks of the S&P 500 on the day before a Fed policy announcement, selling them a week later, then buying them again the following week and sticking with the pattern until the subsequent Fed meeting generated a whopping 650% return since 1994, far outperforming the inverse "odd" strategy which shocking had a negative return over the past two decades years

Mind Over Markets - Dalton (Volume Profile)
Opening Types -

• Open Drive - 
• • if market opens above or below prior day's range or value area, then an Open Drive is dominated by responsive buying or selling
  • if market moves away from prior day's range, than the open is dominated by initiative buying or selling
  • You want to detect this early and not trade against it - OTF is active and aggressive
• Open Test Drive
• • Market opens, moves a short distance in one direction and then another advertising for someone to step in.  
  • This will usually test a prior key area and then push once it has gained conviction that nobody is left to oppose it.  
  • OTF has found an area of conviction to participate in the opposite direction
• Open Auction in range - 
• • nothing has changed between this session and the last.  
  • Market will be unfriendly to breakout traders and reward those who trade from the outside in
• Open Auction out of Range - 
• • outside of the previous traded range.  
  • There is a high probability of OTF action and these can be big days.  
  • There will be a higher level of conviction by responsive as well as initiative traders.
  • expectation is to go back into yesterday's range or value area
  • • if price does not go back in, OTF is absorbing and it will likely continue to push
    • look for test of previous high or low

Day Types - 

• Non-trend - complete balance, no OTF
• Normal - everything inside IB
• • MPD_IB_RNG >= 0.85 * (HI - LO) AND (HI = MPD_IB_HI OR LO = MPD_IB_LO) AND (HI - LO >= 18 * 1pt range)
• Normal variation - IB high / low breaks
• • IB range < 0.85 * (HI - LO) AND IB range >= 0.50 * (HI - LO) AND (HI = IB_HI OR LO = IB_LO)
• Neutral day - OTF present, so range extension on both IB
• • Neutral: HI > IB_HI AND LO < IB_LO AND CL < (IB_HI + HI)/2 AND CL > (IB_LO + LO)/2
  • X: HI > IB_HI AND LO < IB_LO AND (CL >= (IB_HI + HI) / 2 OR CL <= (IB_LO + LO) / 2)
• DD Trend - builds energy from one range and then quickly moves to another and balances
• Trend - OTF remains active throughout the day
• • MPD_IB_RNG < 0.50 * (HI - LO) AND (HI = MPD_IB_HI OR LO = MPD_IB_LO)

The Big Picture- 

• Market, Structure, Trading Logic, Time
• Time - regulates opportunity
• • Good opportunities to buy below value and sell above value will not last long
  • • If the inventory doesn't move quickly, and stays below value for longer than 'expected' value has changed and it is now being accepted lower
• Structure 
• • range extension - identifies control and helps gauge buyer / seller strength.  
  • • the stronger the control the more frequent and elongated the extension, ie:Trend day
  • 30 min auctions
  • open and close
  • profile shape
  • tails - aggressive buyer / seller enters the market on an extreme and moves prices quickly
  • • lack of tails mean lack of OTF conviction
  • initiative vs responsive
  • • initiative buying - any buying occurring within or above the previous day's value area
    • responsive buying - any buying occurring prices below value
    • • initiative selling on range extension can result in responsive buying
  • Time Frame control
  • • Day 
    • • open, mid, previous close, high and low of previous day, current day, week (only if near the current price)
    • OTF 
    • • bracket highs / lows
      • weekly/monthly high / low
      • unfilled gaps
      • common MA
      • if these are in control switch from rotation to momentum trading
    • Destination - once a directional trade is underway, look for obvious visual cue
    • • Day - phod, plod, 3d high / low, top / bottom of a gap
      • OTF - long term bracket high / low and it make take months to reach there
      • • Monitor for continuation!
  • Trending vs Bracketed Market (Trading range)
  • • Trending market
    • • must determine if trend is continuing
      • is price accepted or rejected by market - are 30m value areas overlapping or separate?
      • market profile is not as useful, since the direction is obvious
    • Bracketed
    • • Markets trend, balance, and then turn around
      • Different market participants have different views of value, and these are often conflicting
      • market profile is more useful because the composite gives the views of all these participants over several profiles
    • 
      

• Trading Logic
• • byproduct of experience, it is an understanding of why the market behaves a certain way
  • ie:if there is a large tail, and a rotation back into the tail, and TPO builds over time, trading logic says that the OTF that moved quickly is no longer present or willing to respond to those same prices
• Extra
• • Must ask the following questions:
  • • Which timeframe responded to price?
    • How strong was the response, represented by volume?
    • Were the responders the innovators, early adopters, early / late majority or laggards
    • Were the innovators responding opportunistically to the actions of the late majority or laggards?
  • Preparation
  • • Review Monthly, Weekly, Daily bars for excess / trend
  • Overnight Inventory
  • • if inventory is long and market doesn't adjust on the open, it is a strong market in the short term
    • 
      
• Markets ultimate purpose is to facilitate trade
• • Which was is the market trying to go?
  • Is it doing a good job in its attempt to go that way?
• 
  

Day Trading

• Day trader begins each day with a set of expectations that serve as guidelines, based on the market's past performance
• • Study of long term direction, recent value area placement, and opening print
• Opening Call - overnight session?
• • opening call gives an idea of what will happen the 1st 30 minutes to 1 hour of the session
• Open
• • 1st 30m of the day establishes 1 of the extremes 50% of the time
  • Directional conviction
  • • open  drive (OD)
    • • market opens and aggressively auctions in one direction
      • price never trades back through opening range
      • • price where open drive fails is important
        • if price moves back through opening range, something significant has changed
      • generally caused by OTF who have made their decisions pre-market.  
    • open test drive (OTD)
    • • similar to open-drive but market lacks the initial confidence to drive immediately after the bell
      • market usually tests beyond a known reference point (phod, plod, previous swing hi / low) and swiftly moves back through open
      • often establishes one of the day's extremes
    • open rejection reverse
    • • opens, trades in one direction w/o much conviction, reverses back through opening range
      • more common the OD and OTD
      • initial extremes hold less than 50% of the time
      • normal / normal variation day should be expected
      • ON high / low will likely be tested
      • strong moves will likely be retraced
    • open auction
    • • market randomly auctions around open w/o much movement
      • conviction depends on where the market opens relative to the previous day
      • inside previous range 
      • • non-convictional day is likely to develop
        • market sentiment from previous day is likely unchanged
        • market auctions in one direction until activity slows, then the other
        • non-trend, normal, neutral days
        • initial balance unlikely to hold
      • outside range 
      • • good potential for market  to move in either direction
        • often gives rise to double distribution days

• Open vs previous day profile
• • open out of previous day value / range indicates imbalance and more opportunity
  • acceptance (auctions within previous range for 1 hour) indicates balance
• OAIRIV - within previous value and is accepted
• • range will rarely exceed the previous day range 
  • one of the previous day's extremes will generally hold
  • • use MM from an early extreme to find the likely range
• OAIRIV - within previous value and rejected
• • drives out during the 1st 30
  • very hard to determine how far, or in what direction market will go
• OAIROV - outside previous value and accepted
• • value will generally overlap previous days value, but only on one side
  • range is reduced compared to previous day
• OAIROV - outside value and rejected
• • range potential is unlimited
• OAOR - accepted
• • as long as price does not return to previous day's range the market has accepted the breakout, even if it auctions back and forth
  • if market continues to drive in direction of breakout range potential is unlimited and Trend day usually results
• OAOR - rejected
• • market is rejected back into range
  • expect price to check accepted value
  • price range is still unlimited, but likely in the opposite direction of the breakout

• 30m Auctions
• • Auction Rotations
  • • successive 30m auctions where low < plow or high > phigh= 1 time framing (1TF) - only buyer or only seller in control
    • if the auctions overlap it is 2 time framing since both buyers / sellers are in control
    • 1TF on 30m indicates Trend day
    • 2TF on 30m indicates normal, normal variation, or neutral days
  • Extremes - Strong high  / strong low
  • • tail provide the most evidence of timeframe control
    • no tail on the extreme is significant, it indicates lack of conviction
  • Range Extension
  • • less overlap = stronger control
    • must take into account the bigger picture elements
  • Time
  • • ability to identify difference between enough time, and too much time is the key to anticipating a change in control
    • this is intuitive to each trader
• Identifying Time Frame transition
• • No transition - entire day is 1TF or 2TF
  • 1TF to 2TF
  • 2TF to 1TF
  • 1TF to 1TF
• Auction Failure
• • follow thru - when market auctions through a known reference point
  • • new initiative activity will fuel the continuation
    • auction will fail and not follow through - will often fail with speed and conviction
  • failures at longer term reference points are larger than short term reference points
• Excess
• • market auctions too far and aggressively moves in the other direction
  • only useful in hindsight - should serve as support or resistance in the future
• Point of Control (POC)
• • fairest price of the day

Profile Shapes

• Short Covering Looks like a P
• • it is old business covering their positions, and it is unlikely to break to the upside
  • usually happens after several days of selling.  Once imbalance of covering is over, trend continues down
• Long Liquidation looks like a b - it is the opposite of short covering
• Ledges - sharp drop that indicates a breakout lower after a lack of continuation
• High Volume Area
• • has tendency to attract price and slow it down
  • the longer price is away from the HVN, the less significant it becomes
• Low Volume Area
• • typical in unbalanced trending markets
  • should hold against future auction rotations
  • if pierced significantly price should move quickly through it

Directional Performance - is the market doing a good job?

• Volume - once direction is known volume, is the primary means to determine performance
• • lack of volume indicates rejection
• Value Area placement 
• • higher, lower, inside, outside
• Trading Brackets
• • All trades should be placed responsively
  • Markets test the bracket extreme 3 to 5 times before moving to new levels
  • Markets fluctuate mostly in the bracket, not at the extremes
  • Must wait for price acceptance before buying breakouts
• Trend
• • the stronger the trend, the greater the beginning of the trend's move
  • must just get on in the initial stages of the trend and monitor for continuation 
  • later in the trend you enter responsively
  • volume on days against the trend will help you determine if trend is healthy
• Auction tips
• • markets need to auction too high to know they're too far
  • pay attention on these days to see if prices are accepted or rejected beyond their composite values areas

Long Term Profiles

• Start these profiles when a significant change has occurred

Special Situations

• 3 to 1 days - initiative tail, TPO count and range extension
• • following day should open within or above value
• Neutral Extreme - days are likely to open in the direction of the closing activity
• Value Area rule
• • gap outside previous value offers support / resistance against price probes
  • if price makes double TPO points within value, it is likely to test all the way through value
  • • closer distance to value makes it more likely to trade through
    • value area width is a sign of poor trade facilitation and lower volume, higher probability it will trade through
    • long term market direction
• Spikes
• • If spike occurs at the end of the day
  • • if open in or beyond the spike, most likely price was accepted, look to enter a the long at selling spike high
    • if opens in the other direction price most likely rejected
• Balance Area Breakout
• • Some of the best trades to take where risk is minimal and reward is great because it is the start of a big move
  • if the move is accepted go w/ the breakout
• Gaps
• • day gaps usually filled within the 1st hour, if not higher likelihood it will hold
  • gaps too far away usually are met with responsive activity to narrow the gap, wait for the initiative activity to return before entering

The Daily Trading Coach - Steenbarger

ch. 1 - change

• Recognizing Emotions: There is no way to block feelings / emotion.  All you can do is recognize you have them.  This will give you information into how you can shift your perspective.
• Make an emotional thermometer.  When we're most frustrated and most overconfident, is when we're likely to make our worst trading decision.
• When you identify an elevated frustration temp, turn away from your screen, and fixate your attention on something else, music or imagery.
• You must sustain the changes you make, do no relapse back to old habits.  Use whatever emotion force that makes you desire to choose trading as a career to fuel this change.

• Goals: Performing efficacious at work that is important to us generates mirror experiences of competence and self-worth
• structured pursuit of goals is one of the best means for creating positive mirrors because we generate construct opportunities for power, self-affirming emotional experiences
• goal is something you can have control over - a trading process, not profit target.  goals:
• increase size incrementally, exiting trade in stages, limit trades to setups w/ market trend
• at the end of the day, make a report card based on how you achieved the goal
• if you fail to achieve a good grade, improvement becomes the goal for the next day.  if not, make new goals
• Visualize your goal before you start trading
• Upon reaching your goals you must experience yourself as a success.  If you see yourself as successful you will feel the joys of success.  Goals are not making lots of money, goals of good trading are things like controlling position sizing, entering long positions on a pullback, ect.
• Process goals answer the question - what would make my trading day a success today, even if i don't make money?

• Confidence:
• You must prepare for the market, this will make you feel as though you deserve to win
• self-confidence is knowing that you can handle the worst - surviving the many occasions of being wrong
• Make memos of what you did wrong, send it to a trading buddy to follow up w/ you a couple days later
• Change
• You will only change when you're ready to change
• Choose 1 goal to work on intensively at a time, if you choose too many they will become watered down
• Don't relapse when you first make the change.  Double your efforts to keep the change going
• Perform specific exercises and actions that are consistent w/ the change, don't just think about it
• As you complete one goal, find the next.  You can always become a more consistent trader.  Self improvement never stops

ch. 2 - stress and distress

• Our interpretation of situations turn normal stress into distress.  Trading is always stressful, but should not turn into distress
• How to prevent distress
• Position sizing guidelines, per trade loss limits, per trade price targets, and daily loss limits
• risk per trade should be meaningfully smaller than potential reward of profit targets
• amount of money of daily loss should be a fraction of the money you make on your best days
• no single daily loss should be so large to prevent you from making money for the week
• Journal
• Every time you experience a distinctly negative emotional reaction to a market event, ask yourself, "How am I perceiving the current market as a threat"
• Identify the perceived threat and turn it into an opportunity.  Write it down in a journal
• Journal has 3 columns, it must be detailed enough to understand what is going on in your mind at that time: 
• Specific situation in the market, 
• transcribe your exact thoughts / feelings / actions taken in response to the situation, 
• consequences of the particular cognitive, emotional, or action patterns taken in column 2. => goal is to become aware, not change, do for 30 days
• You can add a 4th column, with what a friend might say to you that was positive about your thinking / trade idea
• It is an emotional exercise, not logical.  It needs to have the power of emotional force, and vigorously reject the negative thought patterns.  These thought patterns have sabotaged your trading, cost you money, and threatened your success
• Trading rules - to create repetition
• rules for risk management; taking breaks after large or multiple losses, entering at defined signal points, preparation for the day.
• review rules before trading and visualize yourself in different trading situations following the rules
• review rules during the day
• grade your rule following at the end of the day, if you get less than a B, it is an explicit goal for next days trading
• Fear
• Fear is a cue to examine your trade more deeply, not make changes.
• Make a checklist of things you look for to make sure your trade is working, and whether it makes sense to be in it.
• Performance Anxiety
• Thinking about the outcome of a your performance will interfere with the process of performing.  Focus on the doing, and the outcome takes care of itself
• Know your niche and only trade that product, time frame, and setup.  Most of the time bad trades come from trading out side your performance zone
• Label trades as A,B,C.  A are home runs, B are good setups, and C are marginal setups.  When you lose your edge or start a slump, only take the A trades are reassess the market
• Volatility will cause anxiety if you are not aligned w/ the market.  If you expect high volatility, but market is low, you will expect moves that never occur.  If it is high and you expect low, you will get stopped out too easily.  You will also not size your positions correctly
• You need many fulfilling activities in your life, so if trading isn't working out particularly well, you have other things you are being successful at
• Rate yourself on spiritual interests, artistic activities, athletic pursuits, social life, intellectual life, family, community and hobbies.  Select 1 area for cultivation to improve emotional diversification
• Maximize Confidence
• It's easier to stay in a trade if you have a defined profit target because you get less caught up in the up and down ticks of the market
• You must know the historical odds of the market acting in your favor.  Without this it is hard to have confidence in the ideas.  Markets experience normal retracements on the way to to a profit target, and those adverse excursions will be difficult to weather
• these pullbacks can be viewed as threats to paper profits or opportunities to add at favorable prices
• It takes more confidence to sit through a trade than to enter it
• Most people will choose a 100% chance of making $1000 vs 75% chance of making $1500, even though on avg you get $1125
• Processing retracements
• a lost paper profit is not a threat to your account
• most criticize themselves for missed opportunities or lapse into a state of frustration
• it is the self blame and discomfort of second guessing you are avoiding  when  you take a profit before your profit target
• Confidence is trust
• you must act on your trade ideas and see through to their planned conclusion to develop trust in your ideas.
• Leave on a small portion of your position to your intended target to help you build trust in your ideas

ch 4 - How to Journal

• How to review your trading journal to self diagnose
• divide entries into 2 clusters, successful trading and trading at your worst
• look for things such as trade frequency, trade size, coping with market challenges
• Compare best trades vs worst trades w/:
• emotional patterns - distinct differences in how you feel before and during trades
• behavior - differences in how you prepare trades, manage them 
• cognitive patterns - thought process or concentration level
• physical patterns - energy level, tension, relaxation, posture
• trading - sizing, times of the day, mode of entering (scale vs all in), instruments traded
• Watch for:
• impulsive of frustrated trades after losing ones
• risk averse / failing to take good trades after a losing period
• overconfident during a winning period w/ marginal and unplanned trades
• anxious about performance and cutting winning trades short
• oversizing to make up for losses
• ignoring stop-loss levels to avoid taking losses
• working on trading when you're losing money, but not when you're making it
• caught up in moment to moment action vs actively managing a trade, preparing for the next trade
• beating yourself up after losing trades / losing motivation for trading
• trading for excitement / activity rather than making money
• trading because you're afraid of missing market move, rather than favorable risk / reward
• Best traders continue to compete against themselves long after they have made enough to retire.  They are constantly trying to improve rather than make money
• Journaling is an emotional exercise, not a cognitive one.  You must learn to hate your worst trading habits so you do not repeat them because they disgust you.
• Keep yourself solution focused:
• What did I do well today/this week? What did I do right about this trade?
• Usually many trading problems come from 1 core problem: ie: negative self talk causes missing good trades, sizing position too conservatively, cutting winning trades too quickly
• Imagery
• Mentally summoning stressful market scenarios and imagining in detail how  we want to respond to these, we inoculate ourselves against those stresses by priming our coping mechanisms
• Visualize specific market / situation, levels, and PA.  the realism enables the exercises to substitute for real experience
• Visualize like a movie, playing out real time
• Imagine from beginning to end, until the entire situation no longer evokes emotion
• Slightly vary the scenario
• Repeat the visualization daily
• Imagine how FT or Lak would trade the same market

Ch 5 - breaking old patterns

• Past relationships are the basis for your identity.  How you reacted to past relationships will affect how react to current relationships. Relationships can be with anything people or markets.
• One trader defended against loss by never getting too close.  He lost a sibling when he was young and his parents tried not to dwell on the tragedy.  He never committed to anyone, to keep his from experiencing his pain of loss, but never had a fulfilling emotional life.  He traded with ludicrously small size, and was distracted by chat rooms / reading web sites.  He avoided loss in relationships, dabbled at the edges of markets, and never achieved anything close to his potential.
• To crystallize your pattern you need to understand the underlying need.  The trader above had an overwhelming need for safety and took the safest path in relationships and trading.  He is guarding against the vulnerability of investing in oneself and losing that emotional investment.
• Patterns can be broken down:
• Need - what we are missing, what we crave
• Feeling State - distress associated with not having that need met
• Defense - what we do to cope and avoid the painful feeling state
• repetitions - how we replay defenses in current situations
• consequences - negative outcomes from our current defensive efforts
• Schemas are habits of negative thought patterns that hijack your mind and the way your process information.  You need to feel the horror of losing control of your mind / behavior
• justice - i put in my work, i should make money
• catastrophe - it would be terrible if my trade didn't work out
• safety - i can't act the market is too dangerous
• self-worth - i'm a total failure, i can't make money
• rejection - i'll look like a fool if i can't succeed at this
• Market is not about you
• When you start using "I" and "me" your attention is becoming self-directed. 
• Need to break this thought process
• Worry
• visualize worst case scenario and how you would handle it constructively.  
• What are you really fearful of?  what unresolved situation is looming?
• until you face it, it will intrude in your work and affect your mood
• worry reinforces a sense of hopelessness and helplessness in the face of those scenarios
• worry masks larger concerns
• once you anticipate the worst case scenario, you can take catastrophe out of the situation
• you don't drive on the opposite side of the road because it is dangerous, you don't have to think about it, you just do it.  You should have the same rules with trading.  Internalize the rules so you it doesn't even occur to you to do dangerous things
• make sure you are emotionally connected to the rule, ie: remember the times you violated the rule and what happened
• Common rules:
• • Position sizing
  • limiting losses - per trade, day, week
  • adding to position
  • when you stop trading or limit size / risk
  • when you increase size / risk, per trade / per day
  • entering and exiting
  • preparing for the day / week
  • diversification among position
• during every change process you will relapse to your old ways, this is common and expected, until they become automatic
• Imagine situations where you feel fear, greed, frustration, and boredom.  Imagine yourself tempted to react in your normal patterns, and the vividly envision keeping those negative patterns in check

Ch 8 - coaching as a trading business

• trade management - the market generates information once you are in the trade, use this to your advantage
• he has 6 units, and only enters trades w/ 1 or 2.  If his ideas are confirmed, he adds units on pullback
• you must cultivate an aggressive mindset when you know you have the market nailed.
• add to your position on paper after you've entered and track how well these 'nailed' positions perform
• Experienced traders know when they are right and wrong.  Beginners try to avoid being wrong.  Experienced traders know they'll be wrong on a significant portion of their trades.  Their coaching is designed to help them anticipate and manage losses