Dan Passarelli, CEO - Market Taker Mentoring

In this video, I want to talk about something really, really useful - under certain circumstances - and I'm dying to share with you. What we're going to talk about today is where to find and how to use market depth.

On the Think or Swim platform, you can find it under the Trade grid section here under the analyze tab when you're in the add simulated trades. If I'm looking at getting into a trade or getting out of a trade, I might be kind of sizing it up and maybe I need to see how many of them I can trade or something like that.

I always go into the analyze tab under add simulated trades, even if I have a position on and maybe I need to buy some of these July 1st 690 calls. Now, I see that there are only five offered here, right? I always keep a size column that has both the bid and the ask in one single column, (so it doesn't take up much space). But I noticed that there's nine offered on the 685's, ten offered on the 695's, and it just seems like a smaller size.

I start to think especially if I have to buy like ten of them or something. Why is that? Could there be a reason? Or could it just be that maybe there's one retail customer who has an order in mid market on one of the exchanges and there's only five there? I want to dig a little bit deeper.

What you can do, if you're using the Think or Swim platform, is you can just click on this little M or the C, the X, any of these little letters next to it that basically is the exchange code, what exchange that has the best bid or the best offer. All I do is I click it and it pops up right here under Trade Grid. Now, on this side, this is Apple stock. I'm just going to change it to Tesla stock since we're looking at Tesla.

But honestly, I'm really not even going to look at this column at all. I'm going to look at this one, this one, and you can see the symbol here. It's a bunch of letters and numbers that represents this particular option, and that's the symbol for it.

You can see it's $47 bid on the PHLX, on this Z, on Box, on Nasdaq and on Amex. Can I slide down here? And then it's a much lower bid on C2 and NYX. But what we're concerned about is the offer because we're looking to buy them. So there's five offered on the CBO at 47.95. But then on Nasdaq, there's some offer too. On this Z exchange, there's some offered too.

So maybe this five is not really indicative that it's just one single order. That's just showing that there's five offered on this exchange whose code is M. And so I can probably buy more than a five lot, and that gives me some good information. If I see just a small amount offered on just one exchange, then that's probably all there is, right? But if there's like, 10-15 offered on several different exchanges, that's all market maker offers. And I put in a bid to buy like 25, the market makers will probably continue to fill me, but a retail customer won't. That's all they have. S

o this becomes really useful information. I hope that helps.

Dan Passarelli, CEO - Market Taker Mentoring

I want to start off today's video with a question for you. What is the typical bid ask spread width for the short term within one week to expiration SPY at the money calls? What is the typical bid ask spread width of the short term within one week expiration SPY at the money calls?

Well, I know from looking at it when the market is open, of course they get a little bit wider when the markets closed. But if you look at it when the markets open, they're typically somewhere between maybe $0.02 to $0.05 wide. Okay?

There are times when the market moves a lot when it could be different than that. Take for example, June 15, which was the last Fed announcement. I happened to be sitting in front of my computer, which I usually am, and I was doing my podcast. In five minutes after the announcement, I clicked to record this video. Now take a look at this video.

Notice that the prices of course, are moving around quite a bit because the underlying is moving around quite a bit. Lots of bids and offers are coming in. But if you'll notice the bid ask spreads are quite a bit wider than they typically are. We can see 10, 15 cents and 20 cents, and that's a lot wider than they typically are.

The question is, why are they that much wider? It has a lot to do with volatility. When a market maker buys a call, the first thing they do is they sell short the underlying shares to get delta neutral. And if they sell a call, they buy the number of shares to get delta neutral. So if the underlying stock is moving around very fast, the price might change on them and they might end up getting a very bad fill. So they have to make up for that risk by widening out the bid ask spreads. That's the reason why that happens.

Now, that last Fed announcement, we had maybe about a 2% swing in the SPY underlying shares. But let's go back a few more years, about twelve years earlier, to what became known as the flash crash. That's another time when I happened to be in front of my trading computer. It's kind of a hobby of mine, and I took a screenshot back then.

This is also SPY, and twelve years ago the price was a fair amount lower. This was when the flash crash was going on. I was looking at my screen, I was actually putting together a PowerPoint, and I was like, how can the bid ask spread be like $0.50 wide? $0.80 wide? Looking over here, this is like almost a 1.50 wide, 1.41 wide. How could that be? And then I realized, oh, the price has dropped significantly. The moral to that story is the more volatility there is, the less liquidity there is. Another way of saying that the more volatility in the underlying there is, the wider the bid ask spread in the options.

That's a really helpful little tip that could prevent you from getting into some trouble and getting some bad fills and might even help you to get some even better fills at those moments when you really need it. I hope that helps.

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.

Dan Passarelli, CEO - Market Taker Mentoring

When you're first learning options, or if you took some finance classes in college, you probably learned about this thing called arbitrage. The formal definition for arbitrage is a risk-less profit. And that is something that economists will tell you should never be possible to exist. It shouldn't be possible.

It isn't possible. But guess what? It actually is possible. I'm going to show you an example of it that I found when I was trading just the other day. So look at the screenshot that I took when I identified this situation.

This was an AMC stock. These were the four day options at the time. It was a couple of weeks ago. And if you look here, these calls, the June 17th, 40 calls were offered at two cent and the 41 calls were bid at $0.02. So there's a couple of really important and interesting things here and a couple of caveats. 

First of all, if I am able to buy the 40 calls at two cent and sell the 41 calls at $0.02, that is owning a debit spread. Owning something that can have value, can have a value of up to a dollar for those of you who are familiar with spreads and paying zero for it. So if I'm able to put that on, if it doesn't cost me anything, it can only lead to a profit, right? So that is, indeed, an arbitrage opportunity. I'll either make zero or I'll make something up to $1.

Now, here's the caveats. First of all, a glaring caveat is that there's only one contract on the bid here, right? So I would have to be quick. I certainly couldn't put in a spread to pay zero because the market makers would obviously see that and say, no, I'm not doing that. You wouldn't trade it.

So you'd have to buy, because you can only sell one of these at $0.02, when you're legging, you'd have to buy one of these at two cent and be really quick and immediately sell one of these at $0.02. Alright? So if you can do that, then you would own the spread for free. But there's another little problem with that.

Most brokerage platforms charge you some form of commissions, but some don't. The ones that charge you commissions, even though it doesn't cost you anything by the options, it costs you something to transact that purchase. If you have a platform like Robin Hood, for example, you could literally put on this trade and look, this trade was really far out of the money, like 300% out of the money or something, right? And pretty unlikely to happen. But if you could make trades like this every single day, and especially if you do more than one lot, if you could just put on like three ten lot trades like this every single day, there's going to be some days when they hit and you will have a business where you have no risk and only profit.

Now, these situations are rare. You don't come across them every time. But I wanted to point out that these indeed are real scenarios and the really savvy traders out there can identify them and can trade them. I hope that helps.

Dan Passarelli, CEO - Market Taker Mentoring

Today I want to talk about a technical technique that I like to use so that you can help strengthen your technical skills and make your trading better: RSI.

It's the relative strength index. And the most common way to use it is to determine, just as it sounds, the relative strength of a trend and what a lot of people use it for. Is the trend getting stronger? Is the trend getting weaker? And then some people look and see, is this trend too strong? Is the stock overbought? Or is this trend too strong to the downside? Is the stock oversold?

But I want to talk about a little bit more of a pro tip here, a little bit more ninja, if you will. Look, we have RSI down here at the bottom in this stock. Happens to be Airbnb. And if you take a look on this day here, we hit a new low in the RSI. And it stayed at that level for, let's see here, one, two, three days.

As a matter of fact, it stayed at this low. And this, at this point, disregard anything to the right of that at this point, this was a low in the stock as well. Okay, fair enough. Then it kind of rebounded and was oversold to rebound here for a day, but then kind of pulled back again. And what happened is we got another low in RSI here today and also another low in the stock.

But what's interesting is that this is a higher low than the previous low, but this is a lower low than the previous low. So this is called a divergence, and it works in different types of stocks. Excuse me. It works on different types of indicators, not just RSI.

There's a few others that we look for divergences in, but when there's a lower low in the stock, but a higher low in the indicator, we always tend to go with the indicator, not with the stock, which at first might seem counterintuitive until you start thinking about why indicators exist in the first place.

They take data and manipulate it to make it easier to understand, to give a clearer picture. So we argue that this is a clearer picture than this. And it turns out that did end up working out. In fact, take a look. We actually even see another higher low with another lower low here.

And by the time we got that sort of third divergence signal, the stock ended taking off, and somebody could have rode that trend up for about two weeks and made a nice little profit on. So that's a divergence in RSI.

Dan Passarelli, CEO - Market Taker Mentoring

We're wrapping up the week with our final video. This week has all been on trading methodology. I want to talk about what's probably the most important step: learn from both your mistakes and your successes.

The best way to do that is to perform what I call a post mortem. Look at your trades after the fact and see what you did right, see what you did wrong, and see how you can improve next time. See why certain things worked or didn't work.

There's a number of ways to do that. Some people will look at their trades at the end of every day, especially if they're very active traders. You could just go to the monitor tab and pull up your trade list.

Then some people will look at them on the weekends, on a Saturday morning, having a cup of coffee and going through the trades of the week saying, okay, here's what I did right here, here's what I could have done better here. Some people who are a little bit less active, maybe your covered call traders; they might just look at it once a month or even once a quarter. But the important thing is that you do put forth this effort and do a post mortem so that you can continue to get better at your process.

That's the whole reason why you're watching these videos to begin with, isn't it? So that you can get better at your methodology.

So, hey, this has been a great week talking about methodology, and we got lots of great stuff to talk about in next week's videos.