1) Defining the Trend
1 of the 12 indicators I use to define trend is an Exponential Moving Average 9 (EMA9)
Whatever data duration you’re using 1 minute or 1 month if price action is below the Exponential Moving Average 9 (EMA9) you’re in down trend, above the EMA9 a up trend.
1.1) Long term trend
Using this link see if you can identify today’s long-term trend using monthly price action.
Example, on the chart below monthly price action is above the exponential moving average 9 (red line) telling us this market is in a long term up trend.
1.2) Medium term trend
Using this link identify today’s medium term trend using weekly price action.
Example, on the chart below weekly price action is above the exponential moving average 9 (red line) telling us this market is in a long term up trend.
1.3) Short term trend
Using this link identify today’s short-term trend using daily price action.
Example, on the chart below daily price action is below the exponential moving average 9 (red line) telling us the market’s short term trend is reversing from up to down.
1.4) Intraday trend
Using this link identify today’s short-term trend using 30 minute price action.
Example, on the chart below 30 minute price action is below the exponential moving average 9 (red line) telling us the market’s intraday trend is currently down.
1.5) Confirming the trend defined by the EMA9 using these indicators
In this example since the 2nd of January 2018 the overall average has changed from a 96% buy.
To an 24.00% sell on 2 February 2018.
2) Trading rules
2.1) Long-term trend, is monthly price action, above or below the EMA9 linked here? above = buy, below = sell.
Does the overall average and long-term technical opinion linked here agree with the EMA9?
If the EMA9, overall average and long-term indicators all agree long term trades of 30 to 90 days in duration are permitted using defined risk strategy.
2.2) Medium-term trend, is weekly price action, above or below the EMA9 linked here above = buy, below = sell.
Does the overall average, and medium-term technical opinion linked here agree with the EMA9?
If the EMA9, overall average and medium-term indicators all agree medium-term trades of 11 to 29 days in duration are permitted using defined risk strategy.
2.3) Short-term trend, is daily price action, above or below the EMA9 linked here above = buy, below = sell.
Does the overall average and short-term technical opinion linked here agree with the EMA9?
If the EMA9, overall average and short-term indicators all agree short-term trades of 2 to 10 days in duration are permitted using defined risk strategy.
Defining the trend is only 1 battle that needs to be won in order to win the war of profitability. How you structure your trades and maintain discipline are as, if not more important.
2.4) In today’s trading environment you have to structure your trades so you are immune to volatility for example February 2018
2.5) It is essential to remove all concerns except getting from point A to B without having to worry about excessive volatility risk during periods like C
2.6) How this is accomplished is by “collaring” every trade
- Collars define risk on the trade and for the duration of the trading period
- They eliminates any possibility of the position being stopped out.
- Properly set up a collar is premium neutral ( does not waste money on net purchases of option time premium)
3) Procedure for collared long positions
3.1) In this example I’m using weekly price action for a trade duration between 11 and 29 days. Weekly price action (medium-term trend) is above the EMA9
The trend is up, = long
3.2) The overall average is a 96% buy confirming the EMA9 defined trend
3.3) The medium-term indicators are 100% buy.
3.4) All agree, medium-term trades are permitted with the trend, trade duration between 11 to 29 days. On the 15th of September 2017 we buy 1 S&P futures contract 2,500.00 contract value $125,000.00, margin requirement $5,050.00
Enter a long position 2,500.00
3.5) Using the angle of the trend we set the profit objective at 2,550.00. We’re anticipating the trend will continue and the 2,550.00 profit objective will be achieved on or before the 13th of October 2017.
Set the profit objective at $2,550.00
(Use support and resistance, volatility, implied volatility and ranges to make profit objectives more precise, to learn more schedule an online review.
3.6) Generating option premium by writing a call against the 2,500.00 long at the profit objective of 2,550.00
15 September 2017
We enter a long futures position at 2,500 (contract $125,000.00)
Write a call at 2,550.00 collecting 15.00 points = +$750.00.
Options expiration, 13th of October 2017
Contract value at 2,550.00 = $127,500
The only way our 2,500.00 long can be called away from us is at our profit objective of 2,550.00 generating a gain on the futures position of $2,500.00
3.7) Using the 15.00 points collected = $750.00 from the call write we buy the 2,450.00 put cost 17.00 points = ($850.00).
The put objectively defines risk on the 2,500.00 long position for the duration of the trading period (until 13 October 2017 expiration)
The put also negates any possibility of being stopped out of the position.
Collected on the 2,550.00 call write = 15.00 points at the profit objective
Paid out on the 2,450.00 put -17.00 points, objectively defines risk
Net cost of the hedge 2.00 points = $100.00, which defines the risk on a position worth $125,000 from 14 September 2015 until 13 October 2017.
3 potential outcomes for this trade, stays the same, goes against us, in our favor
3.8) Outccome 1, The market stays the same and settles on the 13th of October 2017 at 2,500.00
The call we wrote at 2,550 expires worthless, we keep the 15.00 points = $750.00
The 2,500.00 long futures settles unchanged at 2,500.00 = $0.00
The 2,450 put purchased expires worthless, we lose 17.00 points = $850.00
Total bid/ask spreads, commission, exchange & regulatory fees =-$159.78 (or less)
All in net profit or loss = -$259.78
3.9) Outcome 2, the market moves hard and fast against us
The market drops from our entry price of 2,500.00 (contract value = $125,00.00) down 600.00 points -24.00% to 1,900.00 contract value $95,000 in “fast market action”.
During a “fast market” it is difficult if not impossible to liquidate a position (when your on the wrong side).
When the market moves far enough trading is suspended and the market is “locked limit” (for today’s price limits see this link)
If a percentage drop like this occurs it would have no impact on the maximum risk of a collared position because we own the put.
The put objectively defines risk on the 2,500.000 long for the duration of the trading period.
The maximum risk (in this example) is the distance between our entry at 2,500.00 contract value $125,000.00 to where the put engages at 2,450.00 contract value $122,250.00 = $2,500.00 regardless if this market moved to zero.
Loss on the 2,500.00 long futures position (600.00) points = -$30,000.00
The call we wrote at 2,550.00 expires worthless +15.00 points =+$750.00
The put we owned at 2,450.00 is profitable 533.00 points =+$26,650.00
Total bid/ask spreads, commission, exchange & regulatory fees =-$159.78
All in net loss = -$2,759.78 on a market drop of 24.00% in fast market action.
A $100.00 hedge prevented a potential loss on this position of $30,000.
The market moves higher
3.10) The established trend continues to grind higher and the contract moves from our entry on the 15th September 2017 at 2,500.00, contract value $125,000 to our profit objective of 2,550.00 contract value $127,500 on or before the 13th of October 2017.
Gain on the 2,500.00 long futures position 50.00 points = +$2,500.00
The call we wrote at 2,550.00 is offset by the futures, we keep the 15.00 points in collected premium =+$750.00
The put we owned at 2,450.00 expires worthless -17.00 points =-$850.00
Total bid/ask spreads, commission, exchange & regulatory fees = –$159.78 (or less)
All in net profit or loss = $2,240.22.
If your trading desks is on their game they can lay down another position at anytime if you place a “3 way”. An example of a 3 way, buy an S&P, plus, minus 50.00 at a net cost of +2.00 or better for 3rd Friday expiration using weekly options.
Translated you’re long a futures contract. You’ve written a call 50.00 points above the futures fill price. Using the collected premium bought a put 50.00 points below the futures fill price. You paid 2.00 points or less net in option time premium (2.00 X $50.00 = $100.00) to a hedge your futures position through the 3rd Friday of the month.
Procedure for short positions
3.11) In this example I’m using daily price action for a trade duration between 2 and 10 days. During the trading session on the 1st of February 2018 price action moved below the EMA9 for the 3rd day.
Below the EMA9, trend is down = short
3.12) The overall average of the 12 indicators was a 24% sell, this confirmed the trend defined by the EMA9.
3.13) The short-term indicators were a 60% sell, agreeing with the EMA9 and overall average of the 12 technical indicators.
3.14) All agreed, short-term trades are permitted with the trend using a trade duration between 2 to 10 days.
3.15) On the 1st February 2018 you 1 S&P futures contract (ESH18) for March 2018 delivery at 2,815.00 contract value $140,750.00.
3.16) Using the angle of the trend you set the profit objective at 2,740.00, contract value $137.000.00
Your anticipating the 2,740.00 profit objective will be achieved on or before the 9th of February 2018.
(You can make the profit objective more precise using support and resistance, volatility, implied volatility and ranges)
Collaring he 2,815.00 short
- A “collar” defines risk on the trade and for the duration of the trading period
- Eliminates any possibility of the position being stopped out.
- Properly set up a collar is premium neutral ( does not waste money on net purchases of option time premium)
3.17) How to collar a short position
When you enter the 2,815 short futures position contract value = $140,750.00
Write a put against it at the profit objective of 2,740.00
Contract value $137,400.00.
In this example we’re using an expiration on the 9th of February 2018.
When you write (sell) an option you’re collecting option time premium,
On this put write, you’ve collected 27.00 points = +$1,350.00.
The only way the 2,815.00 short can be called away is at a profit
Short 2,815.00 called away at 2,740.00 = +$3,750.00 on the futures position.
3.18) Using the 27.00 points collected from the put write = $1,350.00
Buy the 2,890.00 call, cost 16.00 points = -$800.00
Contract value at 2,890.00 = $144,500.00
The call objectively defines risk on the 2,815.00 short for the duration of the trading period 1 February 2018 through 9 February 2018
The call also negates any possibility of being stopped out of the short position.
The net collected on the collar +9.00 points = +$450.00,
In this example we we’re paid $450.00 to define risk on a position worth $140.750.00 from 1 February 2018 to 9 February 2018.
Potential outcomes for this trade
3.19) The market stays the same and settles on the 9th of February 2018 unchanged from our entry at 2,815.00.
The put wrote at 2,740.00 expires worthless, we keep the 27.00 points = $1,350.00
The 2,815.00 short futures settles unchanged at 2,815.00 = $0.00
The 2,890.00 call purchased expires worthless, we lose 16.00 points = -$800.00
Total bid/ask spreads, commission, exchange & regulatory fees = -$159.78 (or less)
All in net profit or loss = +$390.22
The market moves hard and fast against us
3.20) We rally from our short entry at 2,815.00 (contract value = $144,500.00) 300.00 points +10.66% to 3,115.00 contract value $155,750 in “fast market action”.
During a “fast market” it is difficult if not impossible to liquidate a position (when your on the wrong side). When the market moves far enough trading is suspended and the market is “locked limit” for today’s price limits see this link.
If a rally like this occurred it would have no impact on the maximum risk of our collared position because we own the call.
The call objectively defines our risk on the trade and for the duration of the trading period. The maximum risk (in this example) is the distance between our entry at 2,815.00 contract value $140,750.00 to where our call engaged at 2,890.00 contract value $144,500.00
Loss on the 2,815.00 short futures position is 300.00 points = -$15,000.00
The put we wrote at 2,7400 expires worthless, wee keep +27.00 points =+$1,350.00
The call we own at 2,890.00 is profitable for 209.00 points =+$10,450.00
Total bid/ask spreads, commission, exchange & regulatory fees = -$159.78 (or less)
Net loss = -$3,359.78.78 on rally against us of 10.66% in fast market action.
In this example we were paid $+400.00 to prevent a potential loss of $15,000
Market moves lower
3.21) The short term trend continues lower, the contract moves from our entry on the 1st of February 2018 at 2,815.00, contract value $140.750.00 to our profit objective of 2,740.00 contract value $137,000 on or before the 9th of February 2017.
Gain on the 2,815.00 short futures position 75.00 points = $3,750.00
The put we wrote at 2,740.00 is offset by the short futures position we keep the +27.00 points in collected time premium = +$1,350.00
The call we purchased at 2,890.00 expires worthless -18.00 points = -$800.00
Total bid/ask spreads, commission, exchange & regulatory fees = -$159.78
All in net gain or loss = $4,140.22
If you have questions or comments send us a message or schedule an online review and we’ll contact you to answer your questions and provide supporting links for additional information and/or verification.
Regards,
Peter Knight Advisor
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