Michael (00:00):
Hey everybody, it’s Michael Martin. Thanks for being here. Really excited because I get to chat for an hour with one of my really, really good buddies for a long time, probably 20 years. Sean McLaughlin, you probably know him as Chicago Sean. He works with all-star charts. How you doing today, buddy?
Sean (00:15):
I’m doing great man. The market is winding down for the day. It’s been a wild week here in my house. My wife just celebrated a big round number birthday. I threw a surprise party for her this weekend. We had people coming in from out of town. They finally just left yesterday, so the week is winding down.
Michael (00:34):
That’s right. When the party’s over, everyone has to go at the same time as I like to say, get out of my house. I want my space back.
Sean (00:43):
Yeah, exactly.
Michael (00:44):
Well, happy birthday to Mrs. Chicago. I hope she has a good many more big round numbers on her way. We like theta in this case, right?
Sean (00:57):
That’s right, that’s right.
Michael (01:00):
So speaking of the reason I don’t do interviews all the time is because I really like to think about the emotional and the psychological aspect of trading. But what happens is if you say one or two things about options, you get a thousand responses from people and although I can speak from my own experience, I thought what I would do today is bring in Sean, who’s a real options pro, get a different opinion. You can hear it from another angle and if that helps you, that helps you, it’s all for free. Sean, one of the things that I get, and I kind of razz people about it so they feel antagonized, but I want to have a little fun with people is this whole zero DTE thing. My take on it is that it’s a real trap for small retail traders and that they’re better off paying more money for time value, give themselves a chance to win. I know there’s training programs out there where you got a bunch of teachers and they can I’m sure help you if you’re lucky enough to have access to that, but the majority of people are doing it at home. They do it your DIYers, right? Do it yourself. So when you think about it and your rolling in all star charts, what’s your take on zero DTE? Call me an idiot if I’m wrong. I mean I don’t care. No, you’re
Sean (02:11):
Not an idiot. Look, it’s right that you’re asking about it because the volumes in zero DTE options are exploding. In fact, options expiring today and tomorrow, so like zero DT E and 1D TE are almost equal to all the rest of the options volume out there. So yeah, we should be talking about it. Now I take issue with people who think that the zero DTE options are a new way to make money. In my experience, and I can only speak from my experience, right Michael, but I’ve dabbled with them, I’ve dabbled with them a lot and I’ve had some success, but I have not come up with anything that’s unique or different in zero DTE. That’s certainly anything repeatable that I know I can rely on to make money every day. My thought on what’s going on with zero DTE options is they are great instruments for people and institutions I should say, who want to hedge event specific risks.
(03:15):
Something that’s very binary, very short term. They know there’s a big government report coming out the next morning or something like that. I think they’re great instruments for affordable hedging, but for people who are trading them purely as speculative instruments, they’re very challenging because if you’re buying them right then that means the clock is working so quickly against you. Your timing has got to be nearly impeccable if you’re buying these options. On the flip side, if you’re selling them, you’re taking on a lot of risk for very little reward. If a big move happens, if we have a big rip that you weren’t expecting for, even if you just stepped away to go make yourself a sandwich or something and you come back and the market ripped 20 points in your face, you’re taking on a lot of gamma risk for very little relative rewards. So for people who are coming at zero DTE options with a speculative mind, I don’t know, I haven’t found a way to make money with that consistently yet. But for people who want to use ’em for hedging, I think they’re fantastic. You can get very specific, very dialed in on these specific day you want that risk hedged for and you could do it, especially if it’s very short term, you could do it very relatively cheaply. So there’s my take.
Michael (04:43):
Yeah, I like what you said about hedging these binary events. Don’t forget if there are non-binary options, we have to refer to them as they them.
Sean (04:53):
That’s the environment we live in now. Yes, that’s
Michael (04:55):
The environment we live in. We have to refer to non-binary options as they them. So I admit I’ve tried them to just because I like to speak from an experiential standpoint because theories, who cares? It’s like belly buttons. Everyone’s got one and I don’t really mean belly button, but this is a rated PG show. I think my guess is that there are people who have smaller accounts and for some reason they have this enormous fear about the, but if they’re day trading and swing trading, my take is who cares about data at that point? If you think the instrument’s going to move sharply in the direction, if you’re long calls, you think the thing’s going to move up. What do you care about theta if the underlying is going to move 10 bucks? You know what I’m saying? To me it’s kind of irrelevant. You’re overthinking stuff.
Sean (05:42):
I get it. There’s an entire cottage industry of options practitioners who swear by only selling premium, and I have no problem with that selling premium. If that’s your bag, I know plenty of people who are very successful doing that. The issue is they’re doing it on longer timeframes. They’re selling premium in options that have six months or six weeks expiration, eight weeks expiration. They’re not doing it on an option that expires tomorrow, at least not the ones that are making any money consistently.
Michael (06:16):
And I speak to timing, I admit there’s probably like three dozen people out there who can do this, but for the shorter term stuff, man, your timing has to really be impeccable. So that’s my gripe about everyone trying to sell you swing trading and day trading programs is you can look over the shoulder and see what they’re doing and understand it intellectually, but in order to have the sense of timing that they have, that to me is a whole other skill and it almost has nothing to do with the puts in the calls part. You know what I’m saying? There are just people out there who have a really good sense of how things unfold and options can certainly be a way to capture that while minimizing the risk. And let’s not forget if some of the high flyers out there, everyone has an opinion now about Nvidia and how AI is going to change the world. You’re looking at 700 bucks a share. So yeah, you can buy a call as a surrogate I suppose, but to buy it for two days because the premium’s eight as opposed to 30 for one month’s expiration. I feel like people are kind of misled. And then what happens is you get this kind of, I call it Johnny Cochrane logic, right? If it doesn’t fit, you must have quit, right? Hey man, the glove never fit oj. He didn’t kill the girl. You know what I’m saying?
Sean (07:38):
Allegedly, he allegedly was involved in that.
Michael (07:42):
That’s right.
Sean (07:43):
Speaking as a Buffalo Bills fan, sorry, that’s a little close to home. The juice.
Michael (07:46):
I remember the juice when I was growing up, that was his nickname. So you hear someone say something over and over and over again and then you lose your critical thought and you just accept it as being God’s honest truth. So my whole thing is not only are the better traitors that I know, really contrarian, but they also question everything, especially in their own behavior. They don’t fall in love with their own reflection like narcissists and you really have to see the data, not necessarily the chart pattern. So thank you for that. It’s just look, so if you’re out there and you’re trading things that expire within the week, I hope you kill it, right? I’m not trying to call your girlfriend ugly, but you need to have a voice of reason. And that’s part of what I do here too because after 36 years I’ve seen and heard it all.
(08:33):
I am not saying that these people are snake oil salesmen, but when I scroll through my Instagram reels, I’m seeing and hearing stuff that is just laughable. It’s like a skit out of Saturday Night Live, and we’re going to see that because it’s an unregulated market, there’s no one to say, Hey, you have to have data to back up what you’re saying. People can say what they want. It doesn’t mean that it’s true. Right on. Let’s talk about risk management. So I tend to be a debit buyer myself. I’m like long calls, long calls, long puts. So I have an idea of what the worst case is. I almost never stick around if the thing is moving against me to let the whole thing go to zero, I’m kind of trading out of it. So what do you think someone who’s just starting out in options to do, should they take their risk unit and make that like a hundred percent of the premium or should they buy several multiples of that? So in other words, if they have a million dollars account or a hundred k, they want to risk 1000, do they put a thousand dollars in debit balance or can they put as much as 3, 4, 5 and then get stopped out at say 80% after they’ve risked their thousand? How do you look at that? Probably with respect to leverage, the
Sean (09:47):
Way I look at it is I like to always plan for the worst case scenario, and I have a perfect recent example of this, and this is in Snapchat. I had a position in Snapchat coming into the debacle that happened this week where the stock lost 30% overnight. I had a calendar spread on which we won’t get lost in the nuts and bolts of it, but just know that it’s a defined risks position. The debit that I paid when I put the spread on a month ago is the absolute most I could lose in a worst case scenario. And you know, after what happened this week, I was very happy knowing that my risk was defined and so I lost, I didn’t lose a hundred percent of my trade, but I lost probably 90%. But that’s fine because the position was sized in a way that had I suffered the full loss, it was a loss just like any other loss, totally acceptable within the realm of realm of what’s acceptable for my size account.
(10:45):
So I always approach risk management from the worst case scenario. When I’m doing option trades with defined risk, I want to know what that worst case is. And yes, to your point, I do use stops. I do get out with if a chart pattern is broken that I was leaning against, or if the spread or the option that I’m in loses a certain percentage of its value typically, but not always. Let’s just keep it simple. Let’s say I’m long a call if the chart isn’t necessarily broken, but it’s just going nowhere and my call that I bought for $5 is now trading at two 50, it’s lost half of its value. Generally I’ll cut my losses at that point, even if the chart still agrees with me. But again, I know what the worst case scenario is, it could be a zero and I’m fine with that. So that’s how I think about it. Mike, yeah, try to keep the worst case scenario in mind at all times.
Michael (11:43):
Okay, that’s a good answer. So I think the same way I think for certain positions where I try to have constant risk, I do know markets can gap when I’m trading well, I tend to trade more aggressively. That’s a discretionary element to my own practice, but the thing that I wrestle with is if you take in the series seven, they’ll say if you buy a thousand shares of an instrument, don’t buy more than 10 contracts and it looks good on paper. You don’t want to over-leverage your account. The thing is, is that you’re given away a lot with that type of model and what am I talking about? We’re talking about delta. Delta of any underlying is one, but if I’m buying something at the money, your delta’s going to be about 50. Obviously gamma’s going to be super high, but I think in terms of position sizing, I try to balance both the premium with also the delta because I know if I’ve got the calls and there’s a gigantic move, I’m not really going to participate in it all that much.
(12:53):
Although you can get, I’m sure the numbers, the delta’s going to increase the more in the money it goes, but that’s still a bit of a haircut that you have to take. So I always try to think, okay, balance, how much premium do I have at risk in terms of debit or net debit? I’m really not a net debit guy, meaning spreader or broken wings. But then I think about what am I getting? What is the bang for the buck that I’m getting? Do you look at deltas too when you are looking to establish whatever structure you’re going to put on?
Sean (13:24):
Yeah, certainly If there is a trade that I like, and again, let’s keep it simple with just simple long calls. If I look at that trade from the perspective of a stock trader and let’s say a thousand shares is my trade size, but I don’t want to tie up that much capital that would be required to buy a thousand shares of the stock, what I would often do is I would go into the options market and buy enough calls to target that delta. So in this case, if I wanted to have a thousand deltas, which is what a thousand shares would be, if I was long a thousand shares, that’s equivalent to a thousand deltas, I would buy, what is that 200 calls to target that same size? Am I doing my math or 20 calls?
Michael (14:17):
Trust
Sean (14:17):
It. At the end of the day, Michael, I’m fried. I can’t do the math in my head.
Michael (14:21):
I know you just had the birthday party and all those pain in the ass people at the house. I understand.
Sean (14:25):
But anyway, I would size my call position so that the delta would equal a similar sized stock position, but the benefit being I’m tying up less capital, I’m tying up less buying power so that I can maybe diversify my risk in another trade that is uncorrelated, right? People do that all the time. It’s something I will do from time to time, but what I’ll be mindful of is if I do that, I know that whatever premium I pay for those calls, that’s my max risk. So
(14:58):
If I’m putting myself in a situation where the max risk is larger than what I’m comfortable with and I have a decision to make, the decision is do I want this much leverage with calls? Can I maybe take a smaller position and I’ll get to that target delta eventually if the trade moves my way or do I get a little creative and maybe buy some hedges, maybe buy some out of the money puts just in case. I mean, there’s a lot of different ways, and you kind of hinted at the top of this call about how with options trading, there’s lots of different ways to skin the cat, and that’s both challenging and frustrating to people, but also a great opportunity. It’s challenging because a lot of people, especially people who come from the binary world of futures where you buy or sell and that’s it.
(15:48):
People don’t like that the answers are black and white, that they aren’t black and white. If X happens, you do Y in options. There’s different, there’s no right answer and people want right answers. People crave right answers, right? They want to do it right. Well, I’m sorry to tell you that if you’re bullish and I’m bullish on the same instrument, you and I could trade it with options in two completely different ways and we could both make money, we could both lose money or one could make and you lose. It’s like that frustrates people, but I like it.
Michael (16:20):
I like them because you can really carve out your risk and that to me is the nature of trading. It’s so not about entries. To me it’s all about position sizing more than anything. If you looked at my, I’m like the Jimmy Page of trade entries. I have really good licks, but I’m sloppy as hell. Whereas there’s other guitar players who can hit every note all the time, but Jimmy Page is all balls, and that’s kind of more my style of trading. So what I try to do is I try to carve out where’s the risk, where’s the upside? Unlike a lot of folks, I don’t really get out of bed if I can’t find something where at least looking on the chart I can see a five to one type of ratio. This way when it works out, my winners can pay for a whole bunch of losers, and like you said, sometimes they stall, so I do use time stops as well.
Sean (17:09):
Yeah, that’s actually something, I mean I’ve always been aware of time stops, but certainly in the past year I’ve made a much more concerted effort to focus on getting out of the trades that just aren’t working quickly. Now, I’m not being greedy, but I look back at my trades over the past, I dunno, four or five years that we’ve done stuff with all star charts and I’ve noticed Michael, that all of my biggest winners, the trades that really made my year every year those trades, not every time, but almost every time they started ripping right away, maybe not the minute I got into it, but within a day or two or certainly within a week, it started going my direction and never looked back.
(17:58):
And certainly I had trades that I sat in for six months and then finally worked for me and that’s great, but I adopted the mindset of if all my biggest trades that make my year are all trades that start working right away, then what am I doing sitting in all these trades that are tying up capital for weeks at a time, months at a time doing nothing? I would rather get out of those things a lot quicker at the risk of maybe getting out of a trade that would’ve worked eventually, but the numbers work in your favor when you do that.
Michael (18:29):
God has spoken these words, and I do that with futures, which allows me to trade with bigger size. I don’t look at myself as a day trader. I’m more position trading, but if I do put on a trade, I don’t want to see red and sometimes I’ll be like in, out, in, out, out just because I’d rather trade with the size, not that I’m trying to sit here, double click in my mouse all day, but I want to get in on the trade with the right timing, then have the thing move in my favor, I can then adjust my stops and it really helps me live in a very placated lifestyle in that regard. It looks sloppy as hell, a lot of false starts, but the key is to get the right amount of risk on at the exact right time, and I don’t have time, like you were saying, I don’t have time to sit there to wait.
(19:15):
I had some puts on Disney a while back and I literally got paid the last day and I was like, this is bullshit. I’m not doing this anymore and I made 20% on the actual trade, so whatever, if my risk unit was 1%, I cleared out 1.2 net of commissions. So it wasn’t even anything really to write home about, so it was more of an emotional win or like a theoretical win. It’s not win-win, certainly not one that I want to get involved in and replicate no money in it, but I think the key here is position sizing. Just to take an aside, I wrote about in the inner voice about the inner invoice of trading being long live cattle, feeder cattle. When mad cow hit the tape, hey,
Sean (19:59):
I don’t know, he was over my shoulder, but right on my bookshelf over there, I’ve got the inner voice of trading right there on my bookshelf.
Michael (20:06):
Thank you. Thank you, Sean. That’s very sweetie to say, but man, that was painful because obviously commodity futures are not options and you have unlimited loss potential regardless of whether you’re long or short. The key was position sizing and the thing was limit move against me like five days and that’s 1500 bucks a contract. You’re getting blasted, but the problem is is that people see that and now they extrapolate it and they see that’s why I’m not trading futures now. I’ve been trading futures for 36 years and I can think maybe including that one, maybe two or three total times where I had limit moves against me.
(20:50):
I think options provide a good vehicle for folks who are learning how to take risk home and take risk home overnight over the weekend. It gives you a little staying power. You already can define what your max loss is, right? So I think there is a bit of a misconception and a fundamental misunderstanding of risk. Risk in and of itself is not bad. It’s how you handle it. To be honest with you, and I make this joke when I speak publicly, I trade futures more conservatively than people buy and hold their 10 year treasury notes. You know what I mean? Those things are all over the place. They look like my uncle Vinny’s, EKG, after a big meatball parm and three liters of Coke. My future’s equity account when you trade your equity curve, so you can take and trade it a very aggressive or risky instrument, but trade it conservatively. I think that’s what Sean was saying. So do you ever find yourself, Sean, where you’re in a long call and a long put and you’re like, Hmm, the financing of this thing is a little rich for my account size, let me sell away some of the upside and create a spread or do you ever do that, like ratio spreads or back spreads? Oh,
Sean (22:04):
Absolutely. Once I’ve determined whether or not I’m bullish on a position or bearish on a stock or neutral on stock, once I’ve decided my directional bias, then the first thing I look at is where is the implied volatility in the options? Now for newbies out there who have no idea what I’m talking about, implied volatility is just a measure of the expensiveness of the options premium. When implied volatility is high, that means that you’re paying a lot more to say buy an at the money call versus when volatility is low, the premiums will be much cheaper, and so I want to know where the implied volatility is. I don’t care so much about the actual number that will pop up on my screen. The volatility is 0.8294. No, I don’t care about that. I just care about where is it now compared to where it’s been over the past six to 12 months. If it’s in the upper third of the range, then I know that volatility is high. In that case, I want to be putting on some kind of spread trade in most cases, or maybe I want to be selling premium just being naked puts or maybe a strangle.
(23:16):
On the flip side, if volatility is cheap, then that gives me a little bit more comfort to maybe just buy a straight call if I’m bullish or buy a straight put if I’m bearish. But implied volatility is number one A in the steps for me in determining what I’m going to do to express my thesis.
Michael (23:35):
Thanks for saying that. I mean with options, man, it’s like to me, futures are so clean. You have supply and demand. There’s no Abby, Joseph Cohen, there’s no fed banker, central banker. There’s no ax that can really tell you where beans or cocoa or sugar are going to go, and that to me is kind of disruptive because if you’re in those positions overnight over the weekend, I don’t any more than any type of trader who’s, whether it’s day trading one minute bars or position trading and holding things overnight like I do, no one likes surprises. I don’t want to wake up and find that somebody just upgraded or downgraded or that there’s even just bad news coming in and out of the company like Refco halted auditor, resigns, CFO was arrested. Man, that Refco thing hit me hard. They had actually allocated money to me, so once I saw that, I knew the gig was over.
Sean (24:41):
So let’s talk about, I ran a small commodities fund back in oh three to oh five, and I cleared through MF Global and I moved to another firm. Luckily, maybe six months before that whole thing blew up, I could have been ensnared in that as well.
Michael (24:59):
That was the John Carine bond trade thing.
Sean (25:01):
Yep, yep.
Michael (25:03):
Yeah, yeah. I was affected by both because when I started out and I went out on my own, I cleared EDNF man basically my whole career. So yeah, he ruined that company. I mean, that company went back to 1794 something. Yeah,
(25:20):
So let’s talk about when you are making money, right? There’s so many things to measure. You talked about implied volatility, you have historical volatility, and then you have a whole slew of Greeks, you have charm, you have all of this. If someone’s just starting out, this is overwhelming. There’s so many things to know, so many things like, Hey, my car won’t start. Well, what is it? Is the battery not charged? Do you not have enough fuel? Are the two battery connectors corroded? Where do you start to go through your checklist of what’s material or not? My take on things for any asset class is to really keep things simple. The simpler models are easiest to run. They can be profitable, and then when they start to break, you could at least see what the hell’s wrong with it and take a time out. What do you advise for the newer folks two years or so of experience who are looking at options and they overwhelmed with just the vocabulary of the damn things?
Sean (26:28):
That’s a good question, and I meet people who are new to trading all the time. I run a traders meetup group here in Colorado. We get together a couple times a month and we get new people all the time. And one of the things that’s always said, options when they hear that I tried options, it’s like, oh man, that’s complicated. And look, here’s the thing about options. Options can be very complicated. In fact, there are a lot of people, a lot of successful traders out there who run very complicated volatility skew strategies that you need like a PhD in math that even scratch the surface of what they’re doing that exists and it’s out there certainly, however, that is not how I trade. I don’t know if I’m smart because I keep it simple or if I’m stupid because I keep it simple, but either way, I like to keep it simple. And option trading can be very simple. If you’re willing to learn a couple terms that maybe you’re a little unfamiliar with, and you mentioned the Greeks. The Greeks, all they really do is they’re just measures that tell you how the speed of things are likely to change in the event that X, Y or Z happens.
(27:35):
I always tell people, if you’re new to options, don’t start getting into multi legged spreads and don’t be selling naked risks. These are things that you don’t understand and you don’t want to learn the hard way. What you want to do is kind of wade in either just be a straight buyer of calls when you’re bullish or be a straight buyer of puts when you’re bearish or a very common way, and I call this the gateway drug to options Trading is be a covered call writer. If you own stocks, sell covered calls against your stock and just see how that plays, see how that affects your return streams. See how those short options play against your long stock. That’s the easy way to get your feet wet covered call writing and just buying calls and buying puts. That’s it.
Michael (28:22):
I would concur, and I’ll say this out loud, I’m a guy who looks at the data. I started creating my own trading models using Lotus 1, 2, 3 and kind of writing macros around it, and it’s awfully difficult even to get good data on options to back test, right? I mean, so it’s very, very difficult. So paper trading, it’s not the same as long as there’s no real risk. You really need to feel the burn of making and losing money in order to get the education that you want. And I’ve said it as a guy who teaches traders of all levels, beginners through institutional people and family offices. The best teacher of trading is the actual trading itself. Absolutely. Because so much of you is part of your trading process, right? Sean just said before that he could be in a spread. I could be in a directional trade on the same underlying instrument, and we could both be right and make money. There’s really not only one good way, there’s the best way for you. That’s probably going to be a reflection of your personality. That’s typically how it goes.
Sean (29:25):
I’m glad you brought up back testing, if you don’t mind. I’d like to riff on that for a second. I riff
Michael (29:29):
Baby riff.
Sean (29:30):
I’m a big fan of back testing. I’m a big fan. When I traded commodities, like U trade commodities, I used to run back tests and I used to do trend following strategies and I wanted to run back tests as far back as I could go to see if what I’m doing has an edge that I can rely on. Big fan of it. However, in options trading as much as we want to backtest it is really problematic because even in the most liquid options markets like say like s and p options or TLT options, SPX options, things like that, even the most liquid options markets, you’re still looking at bid ask spreads that are very material. If you’re looking at an option that’s a fair value of two bucks, for example, yeah, the fair value, the option might be two bucks, but the bid might be a dollar 75 and the offer might be 2 25. That is a spread. You could drive a truck through and when you’re trying to backtest and say, oh, I would’ve gotten filled at $2, the fair value, that’s not how the real world works. If it’s a fast market and you need to get out, you’re hitting that bid and you’re getting out at a dollar 75, and that’s a big difference from $2 in percentage terms,
(30:43):
And you combine that over hundreds of thousands of trades, those differences are just going to put your numbers way out of whack. I mean, if someone out there has a good way of backtest options, I’m all ears. I would love to see it, but yeah, I don’t know how it works.
Michael (31:01):
Yeah, it’s got to be something that’s custom made because it’s just too difficult. But backtesting can reveal at least so you miss, right? Because two payoffs to every trade. There’s certainly the financial part, but then there’s the emotional and the psychological. When you’re trading with paper money or using a demo account, you might be frustrated, you can’t get the thing to work, but you’re not despondent. You lost actual money that you worked hard to get in the first place, right? So there’s a really big difference.
Sean (31:32):
Absolutely.
Michael (31:33):
Sean, how do you go about, if you have a bullish opinion on a certain thing and it’s showing up on the chart, how do you kind of determine what’s the best, right? Because you have futures, you have all these different expiration months, which we call the strip and term structure and options. You have $5, sometimes $10 increments in strikes. So is there a Greek or is there just a methodology? Is it a gut feel? What should someone look to if they were bullish on some underlying instrument, what call strikes should they look at if they were going to buy it?
Sean (32:11):
I am afraid I might give you an unsatisfactory answer here, Michael, but it’s all of the above. Remember earlier I mentioned how after I’ve decided my opinion on the stock or the underlying my bullish or my bearish, my neutral, after I’ve decided that, then very next thing I do is determine where the implied volatility is. When I’ve determined that implied volatility, that’s going to steer me into the direction of what strategy I’m going to use. So let’s just use some examples here. If volatility is low and I’m bullish, I tend to to really just keep it simple and buy calls, I mean I don’t need to get any more complicated than that. If calls are cheap, then just buy the calls so much easier. And generally speaking, if volatility is cheap and therefore calls are cheap, I will try to go further out in time because it’s more affordable to go further out in time.
(33:06):
I get more bang for the buck if I get it right. And a really big trend develops, so we’re in February right now as we’re talking, if volatility is scraping the lowest levels it’s been in for a year in a certain name, I might look out nine months, 12 months option strike just to give myself as much time for my thesis to play to work out and the strike that I select. Generally speaking, if I’m buying calls, I like to buy the 25 delta strike, so that’s going to be an out of the money call. It’s going to be above the current price level. There’s no magic in 25 delta. Michael, I get this question all the time. Why 25 delta? What back test tells you that that’s the best one? No, back test tells me it’s the best one. I like it because at 25 delta, to me, it’s the right mix of affordability and leverage. If I get it right,
(34:05):
Meanwhile cheap enough that if I get it wrong, it doesn’t hurt that much. I didn’t risk a whole lot of my capital. So that’s why I like the 25 delta love. If you like to buy the 30 delta, if you like to buy the 40 delta, fine, there’s no right answer. Everything in options trading is a trade off. If you want to make more money, you have a lower probability of success. If you want to have a high probability of success and win more often than you lose, you can do that too, but you’re not going to make as much money. There’s always a balance.
Michael (34:37):
I appreciate that. I appreciate the honest answer. I’ve vacillated between 25 and fifties in recent times. I’ve been buying a lot of at the money stuff just because the moves are so strong, which really kind of brings me to the next question is if you see a move, let’s take a move that a lot of folks probably would know in some of these AI stocks, Nvidia broke out over whatever it was 5 0 5 and at this time, what last night, it was up 7 0 8. So you’re in calls that are going either at the money, in the money very, very quickly or like you with 25 deltas, they’re eventually getting to be at the money. Then in the money, is there a best practice for know and when to roll, right? Because sometimes these moves, you have $30 move overnight, you can’t roll to the next strike. You’re oftentimes the rolling, you’re dealing, you might have 30, 40, $50 in between strikes. So do you enter spreads or do you attempt to offset the winner and then immediately go back to your next 25 delta? How does that work? Because also the volatility might’ve changed.
Sean (35:46):
Yeah, that’s a good question. And what I tend to do, and I’m not saying this is the best way or the only way, but what I tend to do in a situation like that where I’ve got a big winner, it’s going my way. Generally speaking, when I get into a trade, I have a plan. I know where I’m getting out, I know where my stop loss is. That’s the easier part. I also have a plan for if things go my way, I have a upside price target. It’s not a firm target. It’s more like an area usually. But in my mind, what I do is if I get to that price target where I’m sitting in a nice profit, a best practice that I will do often is I will sell or get out of a portion of my position that pays me back my original risk capital. So whatever I initially invested in dollar terms, I’ll sell enough to get that money back and then I’ll hold the rest. I like to call it a free ride, right? Hashtag free ride, I got a free ride on the rest. No matter what happens, I’ve got no risk in it. Trade, yes, I’m risking open profits, but I’ll risk open profits all day long, but I don’t want to risk my original capital.
Michael (36:58):
Yeah, I got you. I kind of borrow from my future trading strategy, which is I tend to be very stingy at the beginning and use lots of times stops, but then once I start making money, I quickly actually scale and buy more. It’s called the moron strategy.
Sean (37:12):
Just kidding. I like that.
(37:16):
Well, Michael, I’ve actually come around on this. I’ve changed my thinking in recent over really the past year, up until about a year ago, my best practice, and I was pretty firm on this, was if I had a position on and the spread or if it’s just a long call or a long put, if it doubled in money, then I would always sell half of my position and again, taking my original risk capital out and then let the rest ride and that’s fine and that works. But after reviewing a lot of my trades, I said, man, Sean, you’re really leaving a lot of money on the table. Why not let these things go to that price target you have in mind and then sell a little bit, maybe just 20% of your position or 10% of your position get paid back your original risk capital and you still got a large position to potentially go to the moon as the kids like to say, it only takes a couple moonshots to make your ear
Michael (38:16):
Trading is great. The outside of Jiujitsu, I don’t know of any other thing that could completely humble you. So I did a similar study and people like to say systems remove emotion or whatever. I mean they don’t know what they’re talking about. Bill Dunn who when he’s retired now, but he would talk about the emotions running through his body and that guy was purely systematic because I kind of journal everything When I think of where I’m emotionally, okay in I bought, say I bought with in the Nvidia stuff, those calls, the at the monies were like 20, $30 with 50 delta, but they go in the money so fast, you’re looking at five times your capital. And so emotionally you’re like, well, I got to protect my capital. I have to put in a stop. If the market’s going parabolic sooner or later it’s going to fall apart.
(39:07):
Parais don’t end all that well, and I don’t know exactly when, but there will be a mean reversion even if the move kind of continues. So you’re dealing with all this stuff in your head. It’s insanely difficult to backtest with options. So I looked and I found that when I feel emotionally I better take some money off the table. If I actually bought the underlying at that point, I would’ve made more money. Kind of like to your point, so your emotions can betray you and stop you from making more money, not just get you into bad trades. The emotional part can hijack your behavior every step of the way in your preparation to your order tickets, to your morning prep, to the execution, to what I call managing the trade. What do you do when you’re in the trade? To me, I immediately put in a protective stop and then I set alerts as it’s making me money. Sometimes I add more, but then I adjust my stops higher. So I like to keep the position might be bigger, but I like to keep as the saying in baseball is I want to steal second without taking my foot off first base. I try to keep a constant risk. I don’t want 10% of my capital going directionally, that’s not 10% of the premium. That’s the distance between where we are and where my stop is. You know what I’m saying? So it’s a little different, but it’s important. Go ahead.
Sean (40:33):
Oh, sorry. I had the good fortune when I first moved to Colorado a little over 11 years ago to strike up a friendship with someone that you may know. Peter Brandt commodity trade has been around a long time. He was featured in the most recent Market Wizards book that came out from Jack Schwager a couple of years ago. Peter lived here in Colorado. He’s since moved, but we got together a few times and one of the things that I learned from Peter the first time we hung out, which has always stuck with me because he’s been trading now for 50 years or something like that, and he’s done fantastically well. He is made many millions of dollars throughout his career, although you would never know, he is the most humble guy in person you would never know. But one of the things he said to me, Michael, he’s like, Sean, in all my years of trading, getting out of losing trades has never been hard for me.
(41:30):
I always have a plan. I always have a stop in. I take small losses all the damn time. He’s like, the hardest trades in the world for me are the trades that immediately go in my favor because every bone in my body has seen this movie before where the thing rips in my favor and then immediately rolls back over and stops me out. He’s like, so every bone in my body wants to take that profit and get out of that trade because I know it’s going to come back on me. But those trades, and this goes back to what I was saying before, those trades that start ripping immediately, those are always my biggest winners. That’s what my biggest winners look like. So I actually learned that from Peter. I’ve only finally started to implement that thinking into my trading. It only took 10 years after he first told me to finally let that sink in. But yeah, man, it’s the emotions you battle and it’s counterintuitive to somebody who’s new to trading or considering trading and has never traded before. It’s counterintuitive to be like, oh, a winning trade that’s hard and losers are easy. But yeah, the winning trades are the hardest trades to hold and certainly been my experience.
Michael (42:38):
Yeah, I feel the same way. And we teach to that too. You have to have a plan for when it doesn’t work. You have to have a plan. Like the old saying on the street is if the market gives you a gift, you have to take it. And there is partial wisdom in that. But I’ve gotten comments via email and comments on the blog on some of the videos where you could tell the guy has no experience or their armchair quarterback and they’re like, dude, every breakout has a pullback. And I’m like, no, it doesn’t grow some hair on your nuts before you start talking and telling me about trading. Sometimes these things go and they don’t stop. So to just say nine times out of 10, it’s like you need to do your history, you need to do your research and know what the hell you’re talking about. The most expensive trade to a person could be taking a winner too soon.
Sean (43:34):
Absolutely,
Michael (43:35):
Absolutely. Times. Have
Sean (43:36):
You seen that, Michael? We’ve seen that so many times,
Michael (43:39):
More times than I care to. I’ve had my share of gigantic winners. I tend to trade aggressively when things are going very well, but the ones that bother you are the moves that take off that you’re not participating in or the ones that you don’t have enough on and it’s like your trade. So you say, okay, well then how can you learn from that? How can I screen better? What was the catalyst that made this thing move? It wasn’t just a breakout to a new hive. Maybe there was a news event, which is kind of hard to predict. So you look at that, but you’re constantly evolving. You never stop learning. You’re always looking at your behavior and trying to ascertain, am I marrying my beliefs with my behavior? For me, behavior predicts where you end up in life. I don’t care what anyone really knows about a certain commodity or an asset class.
(44:31):
If you have trouble sleeping, trust me, I could tell you everything you need to know about the sugar market or yellow soybeans number two, but that doesn’t help me make money, right? That’s not a trading tactic. That’s a data point. Now, 30 years ago when the internet didn’t exist, if you had that type of information, it would mean something, but the whole encyclopedic knowledge now of any type of thing is always a Google search away. So I tend to look at behavior and what is it that I know how to do that I could execute, that I could kind of quantify or journal, and that might even be certain sensations or feelings that I get or hunches. I actually write that down, okay, where’s the hunch? Where did it come from? Was it a news thing? I’m not really big on tv. Did I notice something in the chart? Did really, really bearish news come out on the name or what people would think would be bearish news, but yet the price didn’t budge and it’s still inched a little higher. All that kind of information tells you a lot about what’s going on in the marketplace. So
Sean (45:32):
I think
Michael (45:33):
It’s
Sean (45:33):
Just listening to yourself and listening to your body. One thing I’ve learned about myself, Michael, over the years is, and I don’t know how it happens, but I’ll have a trade on or a position on or just overall portfolio positioning, and I’ll start noticing as I’m looking at my positions that I’m starting to get a little cold sweat going, and I can’t explain. I’m like, I’m not cold and I haven’t been exercising, but all of a sudden I get this cold sweat, and more often than not, that’s my subconscious telling me, Sean, you need to make a change here. You need to get this position off the books or something. It’s kind of amazing how that happens, and it took me a while to figure that out, but that’s one thing that I get. I mean, what was it? George Soros used to say that if his back started hurting, it was time to get out of a position.
Michael (46:15):
I was just thinking about that. Yeah,
Sean (46:16):
Kind of the same thing.
Michael (46:17):
Yeah, I mean, at first I thought you were talking about that Austin Cuban food that we had in Venice the last time you were in la. Oh, yeah,
Sean (46:24):
We got to go back to that because that was great.
Michael (46:27):
Yeah, name was, I think I actually interviewed, her name was, I want to say Flavia Simsa, who would talk about that. I think she was like George’s coach and Victor. When Victor was working at Quantum Fund with Jim Rogers and George, he would say the same kind of a thing. He would feel his body would get a sensation and his back would start to hurt, and that would like to be an entry point to his system.
Sean (46:58):
Speaking of Jim Rogers, by the way, Michael, shout out to Jim Rogers. I had the very, very good pleasure of getting to meet him in person this past summer. I did a trip to Southeast Asia. Me and my partner Steve Strasse, I went to Singapore and we just kind of cold emailed it. Jim Rogers, he didn’t know me, I didn’t know we’ve never met before. I cold emailed him and told him we were in town. We were interviewing traders for a documentary, and to his credit, he’s like, yeah, sure. Come on over. I’d love to meet you. And we ended up spending two days with Jim, had some coffee, had some great conversation, man, what a gem of a guy.
Michael (47:32):
Oh, a hundred percent. Actually, he used to live near Columbia in that big house in Morningside Heights, so I would see him occasionally in New York City when I was in school, and then later on I would catch up with him for lunch or something, coffee in Santa Monica, talk about the old times, talk about managing risk, and I’ve had some really good interviews with him. I probably should have him back on the show. I noticed one thing in my own behavior that he and I shared was that when we were wrong, we were oftentimes early. So we started talking about, well, how could I better position size? And that conversation actually led me to instead of going risk on risk off, why don’t I trade a smaller piece getting involved maybe one fifth my optimum size so that this way if I’m my accuracy is 40%, it’ll be paper cuts as opposed to something that’s more ego-driven, like a plunging.
(48:31):
I buy 150 New York gold contracts. Maybe you don’t have to buy them all at once. Buy three lots of 50, get a feel for the market, see if it’s going to move in your favor this way. Like you were saying, if the market moves against you, I don’t want to get nailed on my first piece, I mean on my entire or my optimal risk unit. I’ll just take a small paper cut on the first entry. So again, so that’s an emotional development for trading that we’re talking about. Anything you want to say about the movie now that you opened your big mouth, the documentary? When is it going to be out? When can we see it?
Sean (49:13):
We expect at least the first couple episodes to be out by April. I hesitate to make any promises. It’s out of my hands. It’s in the hands of the producers and the editors and the people that make movie magic, but I know we’re getting close. It’s slated to be eight episodes. We went to seven cities throughout Southeast Asia, interviewed all kinds of traders, and we visited some of the exchanges in these countries and it was a wonderful experience and hopefully we’ve got some great content out of it. We’ll see.
Michael (49:49):
Dude, I have no doubt it’s going to be great just who you are. You’re one of the good guys. So I have one question in closing before I also want to thank you. I know you’re not a guy who’s just sitting around watching reruns of baseball games like I do. You are very busy in everything that we’ve spoken about today. Are there any other misconceptions or things that many people misunderstand about options, especially if they’re kind of starting out?
Sean (50:20):
I think the biggest misconception about options is people who have no experience trading options just automatically assume that options are incredibly risky. Now I know where that comes from. I know that people see that you could buy a call option and be wrong and lose 100% of the premium, and that sounds scary, and that makes for a great headline and certainly a good tool to scare people. Yes,
Michael (50:47):
It’s a total loss.
Sean (50:50):
Or you hear about the people who sell naked options, naked calls on something that gaps a hundred percent against them or something like that. Yeah, those things happen, but those things also happen in the equity markets and they also happen in the futures markets, and they certainly happen in crypto. It’s not unique to options, but if people are willing to do the work and just do a little bit of reading or just ask the right questions of the right people, you can find out that options trading actually could be very conservative. We talked about the defined risk. You could define your risk to be however much is comfortable for you, right? Maybe you’re only comfortable risking a hundred dollars per trade, fine in the options market. You can craft trades that give you a possibility of winning, perhaps winning incredibly while still managing your downside and knowing how much you’re going to lose no matter what stock could go to zero. You could still know what your maximum risk is. So yes, I understand why people can think that options can be very risky and certainly if you’re doing it in certain ways it can be, but that’s not a blanket truth, right? Options definitely give you a much better ability to be more conservative. I know that sounds crazy to some people.
Michael (52:13):
Well, I think in the context, I don’t want to put words in your mouth, but I look at the same thing too. People say, you’re a commodity trader. It’s legalized gambling. You’re a risk lover. You love gambling. I was like, no, I really don’t Myself. I’ve played games of skill at casinos, poker games and blackjack and this and that. So when I think about losing your total investment, if I break up my money in 1 25 basis point increments, I have 400 chances to be wrong. So if I put down $2,500 for every million and I lose it, sure it’s a total loss, but I still have 99.75% of my starting capital. So for me, it’s the same thing. I don’t really have a loss. Even if I have 99% of my capital, I would still figuratively say I still have all my money. You know what I mean? Yes, for sure. It’s a loss, but we make and lose our money from our account balance, from our position sizing, and that to me is like where the best traders really have an exceptional understanding of risk and they know how to position size the entries and the exits, they can be super sloppy. Obviously you’re trading a tiny account, slippage and skid probably is more meaningful for you, but once you start making some money, that stuff becomes incidental.
(53:33):
It doesn’t mean anything.
Sean (53:35):
As much as everybody would love to just rid themselves of the scourge of losing trades, the fact of the matter is losing is a course of business. It’s an essential part of what we do. You will lose, and depending on what type of strategy you’re employing, you might lose frequently. I mean, you and I both know traders who are fantastically successful, who have a win rate of 30%, right.
Michael (54:00):
Make a huge living with 30% accuracy.
Sean (54:03):
Absolutely. Absolutely. So losing is a part of the game. We’re not going to get rid of it, but it’s how you lose that separates the winners from the losers.
Michael (54:13):
Well, you’re a winner man. I appreciate you being here and taking the time. We’re coming up on an hour. I definitely want to know more about the movie, when the time, make sure to help you promote it, and then we’ll have you back on the show in a couple months. Talk more about options. Maybe we’ll do a little something or it would be great if we did a live stream, we did a demo or a live stream on something. I’ve been kind of toying with that idea. You certainly would be at the top of the list for doing that thing. Thank you, Sean. I appreciate you being here. I appreciate all your wisdom.