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The NO.1 SECRET To Be Consistently Profitable Trading Options | Options With Davis | YouTubeToText
YouTube Transcript: The NO.1 SECRET To Be Consistently Profitable Trading Options
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Summary
Core Theme
The core theme of this video is that understanding and trading the "expected move" in options is the key to achieving consistent profitability. The expected move, derived from implied volatility, represents the anticipated price range of an underlying asset.
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all right alrighty so let's get into
today's video and in today's video I'm
going to be sharing with you what I
believe is the number one secret to
becoming consistently profitable when it
comes to trading options right so I
really want you to pay attention to this
video because I truly believe that this
is the most important video that I've
created so far if not one of the most
important videos that you really should
uh learn and Implement all right so
because I think that if you go ahead and
use this secret which I'm about to share
with you it's going to really help you
become consistent in the results that
you get when it comes to trading options
all right so what is this number one
secret so this number one secret is none
other than What's called the expected
move right so I've actually previously
uh touched on this rather briefly in my
previous video but today I want to go a
little bit more in depth into this as
what I'm going to be sharing with you a
Year's worth of Trades that I did around
the expected move so you can take a look
at the results for yourself as well
right so the very first question you
might want to ask if you're unfamiliar
with this term is what exactly is the
expected move right so the expected move
is basically the amount that the stock
is expected to either go up or down from
its current price right in by a certain
time based on its current level of
implied volatility all right so
basically it's how much a stock can move
right based on the days to expiration
left so basically when we are trading
options you can see that there are these
numbers down here which is telling you
when these options will expire right so
based on the implied volatility it's
going to tell you roughly the expected
move that the stock will make either up
or down right so if you are a
mathematician you really like to take a
look at the formula you can see this is
the formula right I'm not going to go uh
in depth into it right because the good
news is that there's really no need for
you to calculate this yourself right
there are trading platforms that
actually show this to you already so all
you have to do is just get the numbers
from your trading platform right for
example this is TD Ameritrade think of
swim platform you can see that when you
pull up your option chain on the right
hand side you will get to see this
numbers right so the percentage-wise is
basically the implied volatility all
right and on the right hand side of it
is basically the move in terms of the
dollar move based on this implied
volatility so you can see this number
down here says plus 16 plus or minus 16
that means it will go up
or down 16 points all right so it's plus
16 on the top and then minus 16 below so
basically this is what the expected move
is so why is this very important
right so this is important because when
you're using expected move it allows you
to devise a strategy around this right
you if you know roughly the range that
the stock will move at any given moment
let's say for example if you think that
the market could go from this range to
this range all right let's say for
example the stock price right now is
this right so this is my attempt at
drawing a Candlestick right so at this
point of time this is where the range
could be based on the implied volatility
now historical statistics have shown
that the implied volatility usually
overstays the actual volatility that
means that prices tend to stay within
the expected move more than the
probability suggests so for example if
the input volatility says that the range
should be somewhere from this point to
this point well the actual volatility
right actually could be much narrower
that means it could actually only move
from this point to this point now this
this is actually important because when
we are trading the expected move right
you can put on strategies that just
trade in this range right so I shared in
my previous video Market neutral
strategies that means that you actually
do not have to pick a direction in order
for you to make money from markets right
so the traditional way of trading is
that if you want to make money when the
market goes up right you normally just
buy it right so in hopes the market goes
up if it goes up you make money if it
goes down you lose money and if you
short the market right let's say for
example you just sell the shares if it
goes down you make money if it goes up
you lose money but when it comes to uh
trading the expected move you actually
do not really have to pick a direction
you just have to say that hey I think
that the market is going to stay within
this range in the next number of days
which I've chosen based on the days to
exploration and then if it stays there
by expression you're going to make money
all right so here's the cool part about this
this
so probability suggests right based on
the expected move formula right they
have all this calculation it states that
the probability should be 68 that means
that it will stay within this range 68
of the time right from from this point
all the way to this point the
probability is 68 but the actual
occurrences within this range tends to
be higher and if you can see this is a
study done by the tasty trade team let's
just take a look at this expectable
formula on this left hand side so
basically what he's trying to say that
the actual occurrences is actually 85
instead of 68 that means it it actually
stays longer in this range more than
what the probability suggests that means
you actually make money more of the time
so let's say for example you receive a
premium of let's say two dollars and
fifty cents which is 250 dollars
for trading this range and let's say for
example you put on a strangle all right
or an iron condo all right let's say you
get 2.50 that means to say if the market
stays within this range by expiration
you're going to receive the full credit of
of
2.50 Now by probability right from this
uh calculations which they have made it
states that you will only make this 2.50
68 of the time but in actual fact you do
not just make 68 of time you actually
make 85 of the time
and then 15 of the times it will be
losers right so that means now you have
your expectancy skewed towards your
advantage right now you have a higher
than usual way or usual rate
that you're going to make money so that
is why in the long run you're always
going to have a positive expectancy
because this number is actually skilled
in your favor right so this is the
studies which is done by tasty trade and
they even went even further to find out
how this actually works in ETFs right
index ETFs so if you were to take a look
at this uh table down here you can see
that on the left hand side it says the
average realized move that means this is
the move that the market actually made
right the average expected move is based
on the implied volatility that means
before the move has been made they came
up with a formula based on the expected
move and they see that it most likely
could move around 16.57 cents right in
this range but instead of actually
moving 16.57 the actual realized move is
much lesser than that and that's ten
dollars 81 cents and they even broke it
down right so they broke it down as you
can see down here they break it down by
the IV rank so you can see that when
there is a low volatility
the expected move is actually also
higher than the average realized move
and even when it's times when there is
very high volatility and high volatility
normally is when there are Market
crashes right the market moves a lot you
can see that the expected move right
fast surpasses the average realized move
so you can see that actually in all instances
instances
regardless of what the implied
volatility rank is right the expected
move is always more than the realized
move so this is for Spire right you can
see it's the same as well for the other
index ETS which you have done the
studies on you can see for iwm as well
the expected move is higher than the
realized move in all instances right
it's all higher again they did it for
this uh QQQ as well so you can see QQQ
as well QQ tends to be much more
volatile than the other two index ETFs
and even with this index ETF you can see
that the expected move is much more than
the realized moves all right now the
thing is that this implied volatility do
not overstate the actual volatility in
all time frames or rather in all
expiration dates so you can see that
they also did a further study to see
when the expected move actually is
bigger than the realized move so you can
see this is a study that they did since
1993 and this is about 30 years worth of
research right so this is pretty
statistically significant because there
is a lot of data points that they have
taken from and you can see that the time
where the expected move actually exceeds
the actual reality last move is from the
45 days Mark onwards but anything before that
that
you can see that it actually does not
exceed right it's only 45 days from the
45 days marks that it exceeds what does
this mean it means that when you want to
trade expected the expected move and you
expect it to stay within this range then
you want to choose the days to
expression that is 45 days and greater
now if you were to take a look at the
longer days you can see if it comes to
60 days and 90 days the discrepancy is
even bigger you can see that from here
the expected move is 7.9 percent but the
realized move is actually 6.5 so there's
a 1.4 percent difference down here
there's a 0.5 difference and if you take
a look at 90 days there is a two percent
difference so what does this mean so it
seems as though that it becomes a little
bit much more unpredictable uh the kind
of uh move that the stock or the market
will make as the time frames gets longer
so it's almost as though they want to
over compensate for the move because
they're not sure right so in a sense
it's something like you know I rather
have a larger margin of 60 you know then
you know if I make it smaller and then
if I get hit and then I'm wrong right so
they rather make it bigger in a sense
whereby the implied volatility they
overstated by much more than the actual
realized move that is made so that you
know in the long term there's much more
room for error but if you would see that
in the shorter term it's pretty much
it's pretty accurate right so this is
pretty efficient you can see that the
expected move sort of kind of match the
realized movement in fact in this four
time frames the realized move is more
than the expected move but as it gets
longer that's where you can see the
difference is right the expected move is
much more than the realized move so that
is why when we come to trade our trades
our options
we want to choose for somewhere from 45
days to 60 days for me The Sweet Spot is
from 45 days to 60 days because anything
that is longer than 60 days two things
happen right number one
basically the Theta Decay is not as high
right the Theta Decay is not really as
accelerated as compared to when it's
slightly closer to the expiration date
so that is why I do not want to
typically go above 60 days and number
two you notice that the premium that you
get kinds of dropped off right so for
example if 30 days right let's say for
example 30 days you're able to get let's
say two dollars in terms of premium Now
if you were to take this by simple math
if you were to go to 60 days this should
give you let's say four dollars in
premium right because you're just simply
doubling it but instead you do not get
four dollars but instead what you get
maybe you only get let's say two dollars
and 80 cents right so you can see it get
much lesser and if you get to 90 days
the kind of Premium which you get per
day becomes even lesser so if you take
just simple math 30 days times three it
should give you six dollars right
because you just times 3 because it's
just three times of 30 days but instead
of six dollars maybe you only get three
dollars and thirty cents right so as you
can see the premium which you get per
day really drops off as the number of days
days
increases so that is why The Sweet Spot
is usually around 45 to 60 days where
you get a good decent amount of Premium
at the same time you also get a good
decent amount of fatal Decay at the same
time you will see that the expected move
is greater than the realized move so
that means that if you were to trade the
expected move within the 45 to 60 days
your expiration date more often than the
68 suggest all right you will be
profitable all right so this is all
theoretical so how does it actually
plays out right when you actually start
trading it so what I did is I actually
put on a Year's worth of Trades where I
trade the expected move and then I'm
going to show you the results and we'll
take a look together to see whether is
it true that you know it's more than 68
right more than the probability suggests
where it says where it's supposed to be
eighty four five percent or whether do I
actually only hit 68 or is it lower but
the way if this video has been helpful
to you so far I greatly appreciate if
you hit the thumbs up button and also
subscribe to my channel so I can create
more videos like this for you in the
future okay back to the video alright so
there are a number of different options
strategies that you can use to trade the
expected move so for this what I did is
I traded the strangles all right so in
my previous video I talked about uh the
top three most profitable Market neutral
trading option strategies right so
basically it doesn't matter where the
market goes as long as it stays within
the expected range then you are able to
profit right so if you're not sure what
the strangle is it's basically uh just a
short call and a short put combined
together all right so let's for example
you just take a look at this price down
here so what you want to do is you sell
a call above and then you want to sell a
put below as well so basically where you
place the strikes is where you the
expected move is right so for this what
I did is that I tried to place as many
strangle trades as possible I place it
at different days different prices
different expiration dates if you try
and get as many trades in as possible so
that the problem probabilities will work
out so as you can see this is all the
strangle streets that I did for 2022 all
right 2022 as you can see there are
winners and there are losers and there
are quite a number of losers down here
all right this is where the market right
became more volatile than what the
actual impact volatility is but at the
end of the day as you can see it was
profitable right so for this uh strangle
because as you know this is a naked
option strategy where you have a naked
call and a naked put I do not want to
hold it all the way to expiration so for
this I got out at roughly around 21 days
to expiration because I did not want to
gamma to pick up so whether it's a win
or loss I would just get out at around
21 days to expiration so here's the
summary so total I did about 68 trades
and then there were 46 winners and there
were 22 losers and the win percentage is
actually only
67.65 and interestingly enough off is
basically what the probability suggests
right the probability already suggests
that it will be 68 and that's exactly
what I did and I did not actually get
anywhere near 85 and the reason for this
is because there's not a large enough
sample size right so for any statistical
significance you need to at least have a
couple of hundreds to even a thousand
trades for the probability to play out
right it's just like you're flipping a
coin right whether to get hits or tails
it's a 50 50 chance now if you were to
just flip the coin 10 times it's very
easy for you to maybe get hits seven
times and then the tail
just three times but does this mean that
the coin is a 70 chance that it's a hit
and thirty percent chance it's a tail
definitely not right because if you were
to flip a coin closer to around a
thousand times then that's where the
probability will start to go to around
50 right so that is where the law of
large numbers comes in you need to have
many trades that comes in now the second
thing to note is that although we only
had a 67.65 percent at the end of the
day we were still profitable so it
doesn't mean that if your probability is
around the same as what the probability
suggests that you're not going to be
profitable no it doesn't mean that way
it you're still going to be able to be
profitable as long as you manage the
trade well now as you know the strangle
is an undefined risk strategy so
theoretically the loss can be unlimited
but probability wise that is highly
unlikely in fact the biggest loss would
most likely just USB two standard
deviations right so step two standard
deviations is basically the buying power
requirement that you would put up for
this trade right so for the iw1 it's
roughly around two to three thousand
dollars so that's basically what the
broker would suggest could be the
maximum risk now of course there are
times where you're going to lose much
more than that especially like during
the kovic crash but that is why you need
to keep on putting all these trades on
right keep your position sizing small so
as you can see for this all these are
pretty small uh relative to my account
size so as you can see the biggest loss
is only a thousand four hundred ninety
five dollars so this is where you you
can control the losses when you do hit
the losses so you can see from the stats
down here my biggest winner is four to
five and then the Biggest Loser is
1495 dollars now this is something
that's very common for undefined Rich
trading strategies right for option
trading strategies that's undefined
because uh when you have a option
Trading strategy where the probability
of wind is quite High most of the time
you're going to have smaller winners and
then you're going to be much bigger
losers right so although your loser is
much bigger is being compensated by the
high win rate which you have so most of
the people or rather most Traders are
just used to you know having big Winners
and then many many small losers but in
this sense right this is the opposite
right you're going to have many many
many small winners but then you're gonna
have the occasional big loser as well
what's important is that at the end of
the day as long as you're profitable
then that's what matters okay so you can
see the average winner is about 249
dollars but the average loser is
actually not too far off it's about just
only about 30 or so uh slightly more
than the average winner and that's
because the number of losers which you
have is going to be much lesser so when
you average them out your average loser
is going to be actually much lesser so
let's calculate the expectancy so if
you're not familiar what expectancy is
basically it's a way for you to
calculate and see whether your trading
methodology is actually profitable right
so for this the expectancy the way you
calculate is basically the percentage of
the win rate times the average winner
minus of the percentage of losers times
the average loser so you can see it
opens up to 77.61 that means on average
every time I put on the trade I should
be expecting to make
77.61 cents all together in the long run
so as long as I have more occurrences so
let's say if I have a thousand
occurrences let's say in a year then
what I'm looking to make is actually
roughly around 77 times 0.61 times a
thousand all right so you can see
overall this is a profit now there is
another way that you can actually trade
the expected move and the other way is
using What's called the put ratio spread
now the poor ratio spread is different
from the strangle because there is only
one side of the wrist so if you're not
familiar what the put ratio spread is is
basically a shot put all right you have
one shot put
and then you use the credit from here to
finance a debit spread right so
basically you have a debit a put debit
spread here where you have a put option
and then another shot put so total you
have two short puts and then one long
put so this makes the put ratio spread
so if you were to take a look at the
risk graph the risk profile of the put
ratio spread it will look something like
this all right so as you can see uh
there is a 10 ship somewhere down here
and the market price would be normally
somewhere around here right so this is
where normally the market price is so as
you can see there is this 10 ship here
where the profit will be the highest if
the market actually goes down into this
10 and you will only basically realize
this uh big profit down here only when
it's around expiration date so for the
put ratio spread is very different from
the strangle because the strangle first
of all it has both both sided wrists
right you have the wrist to the upside
you have the wrist to the downside
whereas for the poor ratio spread you
see there's absolutely no risk to the
upside so the market can keep going up
for all I care and then I'll still just
get the premium which I received for
selling this put ratio at the start but
as it goes down you see there is an
opportunity for me to make much more
than the credit I receive
and then but if it passes past this
break-even point then that's where this
put racial spread will start to lose
money so before it can actually start to
lose money I want to make sure that
there is a chance for me to make a lot
of money so this is pretty much a very
defensive move so for the poor racial
spread what I did is I basically placed
the short strike down here at where the
expected move is all right so this is
another way for you to trade the
expected move so the put ratio spread
what I did for here is I tried to put on
as many trade as possible and the
difference between the poor ratio spread
and the strangle one thing is that the
put ratio spread is a slow spread so
that means I want to hold all the way to
expiration because I want to have a
chance to hit this big profit Zone down
here all right so for this I actually
traded on the XSP which is the S P 500
mini SPX options index so for this there
is no chance of early assignment because
this is European style options so
basically all your profits and loss will
be realized only at expiration and this
is a cash settlement all right this is a
cash settle option
that means there is no assignment of
shares at all so once the option expires
right so they will calculate whether you
are in a profit and a loss and
everything will be settled in cash right
so if you're lost they will take money
out of your account and if you're in
profit they will just put the money into
your account so as you can see straight
off the bat you can see that there are
many more winners and the reason is
because the poor ratio spread is a very
very high win rate kind of strategy
right so if I were to go back to take a
look if you take a look at the risk
profile if the expected move is down
here all right you're basically a break
even is much lower than this because you
have this embedded long spread down here
so your win rate down here is easily
anywhere from 80 percent to even 90 plus
percent right so that is why you see
that there is a lot of wins compared to
losses in this trades all right in this
uh put ratio spread so again the summary
down here total there's 51 trades all
this all held to expiration so you can
see the winner is 49 winners and there
are only two losers so the win
percentage is actually very high as you
can see it's 96.08 and this is
definitely much much higher than what we
saw in the previous table because
remember the previous table which you
saw where there is uh the actual
occurrences within the expected move is
85 but in this case it will be higher
because you've eliminated one side of
the wrist so there's no risk to the
upside there's only risk to the downside
so as you can see down here the biggest
winner is pretty close to the biggest
loser and that is because of this tent
down here right this tent shape down
here so you're able to actually make a
lot if you hit this uh tent down here
and you realize the the max profit so
you can see that the Biggest Loser is
only around 2010 there's only one time
the second time we only had roughly a
hundred and ninety dollars lost so you
can see that for this the average winner
again is smaller than the average loser
also because the the most of the time
when the market goes up you can see that
it pretty ex pretty much just expired
worthless right so I just collected the
credit right at the beginning so for
this the expectancy again we calculate
is roughly
395.73 and the overall profit is 20 182
so for this the put ratio spread
actually did much better than the
um strangle and the only reason is
because in 2022 this is pretty much a
bear Market you can see that generally
the market has been going down and put
ratio spread makes the most money when
the market is below the current price
where you put it on so there are many
times as you can see in this uh Trace
which I have you can see there are a
number of times where I hit the 10th
right I hit the tent where I'm able to
get much more than the actual premium
which I sold it for right so there are a
number of times because the market is in
basically a bear Market the market goes
down so this is one way for you to
profit in the bear Market instead of
just doing you know trades like iron
Condors or strangles all right so
although this expectancy here is pretty
high chances are it's not going to stay
this way the market resumes its bull
market run right because in a bull
market as you know the market will keep
going up so most of the time if it keeps
going up You're Gonna Miss This 10 and
you're just going to make this uh a
premium which you sold for at the start
all right so the this expectancy chances
are is going to drop off in a bull
market and it's going to pick up again
in the bad market so overall the put
ratios has been very profitable for me for
for
2022. so if you want to get much more
consistency in your profits and in your
results when you're trading options then
you want to look to trade expected moves
options trading strategies all right
guys so I hope that you found this video
very helpful and if has I appreciate it
if you give me a thumbs up and also if
subscribe to my channel as well so this
way I can create more videos for you as
well and as always thank you for
watching I appreciate your time and made
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