Dan Passarelli, CEO - Market Taker Mentoring

I want to show you a really great ninja trick that's a little bit advanced, but it's really easy to learn, actually. Anybody can benefit from using this. Now, let's say you're trading maybe a momentum trade or a super directional trade, and you just are going to implement a very simple long call strategy.

Well, look, the thing about buying calls is that they decay in value. I mean, the thing about buying any option is that they decay in value. That's why a lot of people like to spread, because it spreads off some of that time decay risk. But if you're looking for a big momentum or a big move, you don't want to limit your risk. So you want to buy a call.

Here's how we manage those trades, decide what kind of trade to do and just simply trade better, right? So let's say here in Apple, for whatever reason, is a hypothetical example, but you think the stock is going to head up from this level, where was it, a little bit ago when I recorded this, 132 76. And maybe we think it's going to go up to 138 over the next couple of weeks. A typical trader would probably buy an at the money call.

Those are the most common ones to trade. Some folks like to do in the money. Some folks like to do out of the money. We'll talk about both of those in a second. If I were to buy this call, there's two things I know.

The first thing I know is that it's going to lose fourteen cents a day as each day passes, which includes weekends. Fourteen cents seven times a week. I also know that as we get closer to expiration, that number is going to get even bigger. So what I need to look at is this is how much I can lose. How much can I make?

Well, look, delta controls that. If, of course, I'm right, every dollar Apple goes up, I make $0.52. That's my delta. So the first thing we talked about, time decay is measured by theta. The directional sensitivity is measured by delta.

Here's the question. If I'm right, I mean, there's always the risk to being wrong with the trade. But if I'm right, what I need to do is ask myself, how much does this stock need to go up on average every day to cover my theta? From a really simplistic way of looking at this, we can just say, well, how many 14 cent units are in a 52 cent unit? (This is changed to 51 here because the stock is moving here.)

But all I need to do is go .14 divided by .52. And I know that comes out to $0.27. So basically, if the stock moves 27 cents higher, I make $0.14. Does that make sense if you just think about it. Twenty seven cents times fifty one ends up being $0.14, right?

So every day on average the stock has to go up twenty seven cents a day. So it could go up fifty four cents one day and zero the other day. But just on average. That's what it has to be. Now, if we're doing that for the very short term, that's fine.

We want to be really clear about this. We kind of have to add in the two weekend days to this and basically take 14 times seven divided by five which is going to be a higher number and redo that calculation. And that's an extra super ninja trick for you. And this is something that comes in really useful. I wanted to share with you. I hope that helps.