SMB TRAINING OPTIONS TRAINING PROGRAM

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Disclaimer

Please note: Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Since, also, the trades have not actually been executed; the results may have been under or over compensated for the impact, if any, of certain market factors such as liquidity, slippage and commissions. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risks.

Hypothetical Trades Disclaimer

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The ROCK Trading SystemPart 1 Description ,Configurations and Entry Guidelines

President of Locke In Your Success, LLC

Options Trader

Success Coach

Options Trading Mentor

John Locke

The ROCK was specifically designed as a component of the M21 trading system both as a standalone “position” and as a means of gradually swapping back and forth between M3 and Bearish Butterfly configurations as market conditions dictate.

The system will be demonstrated here as a “stand alone” position and may be traded as a monthly, Market Neutral trading approach.

The system can also be very effective as a modification to both the Bearish Butterfly and M3 Trading Systems in specific market conditions such as “run away” up markets.

The ROCK!Purpose

This trade requires incremental adjustability and must be traded with multiple contracts, therefore minimum suggested size is $50,000 Planned Capital if traded in RUT. If this does not fit in your comfort level, do not trade it live.

This trade can be practiced with IWM however there are some risks which include..◦ A substantial amount of commissions which will negatively effect profit/loss.◦ Using an ETF such as IWM carries both dividend and assignment risks.

Prior to trading this system I STRONGLY RECOMMEND that you have traded and you fully understand both the M3 and Bearish Butterfly trade systems because, at times, this trade literally is an M3 or Bearish Butterfly and this program does not directly address the M3 or Bearish Butterfly guidelines.

All analysis and parameters are based off of OptionVue analysis software with the default settings as of this writing. Results may vary significantly if other analysis software is used or if incorrect settings are used.

Caution

That you have been through and fully understand both the M3 and Bearish Butterfly Trading Programs. If you have not, this may be very confusing, and likely, very costly for you to trade. It is STRONGLY recommended that you go back and learn those systems prior to attempting this system.

It is assumed……

For the technical people out there, I am aware that a number such as -100 is actually greater than -200. However a majority of the people do not instinctively think in this manner therefore….

For the purposes of this program and to avoid

confusion for a majority of people, when we refer to a number as being greater than -200, we mean a number such as -300. And if we say we want a number less than -200 we mean a number such as -100.

Negative Number Clarification

The Rock was originally designed as a part of the M21 Trading System as well as a supplement for the M3 and Bearish Butterfly systems.

The Rock, as presented here is a stand alone trading system, which takes advantage of relatively flat market conditions while being resilient enough to handle a substantial amount of price movement in either direction.

The guidelines use indicators that “modify” and morph the trade for the purpose of adapting to market conditions and pricing skews both at entry and for the duration of the trade.

The trade uses “loose guidelines” as in the M3

Description

Works best in flatter market conditions but will adapt to most situations.

Handles large trending moves fairly well in either direction.

Is most risky to trade in markets when IV is very low and the price movement is excessively choppy.

Easily transitions into a M3 or Bearish Butterfly

Makes an excellent adaptation to the M3 and/or Bearish Butterfly in market conditions that are not optimal for those trades.

Is an essential component of the upcoming M21 Trading System.

Description

Like the Bearish Butterfly the trade scales from a small number of contracts up to 30 contracts.

The trade is considered 1/3 entered with 10 contracts, 2/3 entered with 20 contracts and fully entered with 30 contracts.

Unlike the bearish butterfly the short strikes of the trade are not always 20 points apart and the trade is not always entered in 1/3’s but rather a few contracts at a time. You will often be somewhere “between” 1/3 and 3/3 scaled in, rather than “at”1/3, 2/3 or 3/3 scaled in.

Description

This trade will swap back and forth between multiple configurations.

Rock, Modified Rock, M3, M3R, Cat and Bearish Butterfly

Guidelines will vary depending on configurations.

The normal entry position is considered the “ROCK” configuration.

We will go over examples that cover all configurations.

Configurations

Typical Entry – ROCK ConfigurationLooks like the “Prudential Rock™”

This is what the ROCK looks like when approximately ½ entered

ROCK Configuration 2/3 Entered

ROCK ConfigurationFully Entered

ROCK Configuration½ Entered With1 Roll Back

M3R Configuration(ROCK >1/3 entered to 2/3 entered with 2 roll backs)

Cat Configuration(ROCK 2/3 Entered With1 Roll Back)

M3 Configuration

Bearish Butterfly Configuration

Modified ROCK Configuration

From there…. It can get crazy!

For the demonstrations in this program, we will be using the Russell 2000 index with a planned capital of $50,000. This is the minimum recommended size for this trade.

We will be using both call and put butterflies (all butterflies will have 50 point wings). We will also use ITM calls, OTM calls, vertical spreads and individual options.

We start approximately 30 DTE by setting up 10 put butterflies that are more than 10 points but no more than 20 points below the price of the underlying.

We will then make a judgment about the market conditions based on the Delta and from there we will either perform a Normal ROCK entry, a Modified ROCK entry, an M3 entry or in extreme cases a Bearish Butterfly entry (not shown in this program)

Examples will be using RUT

Normal ROCK entry:◦ Enter the put butterflies and then add a certain number of call

butterflies 40 points over our short strikes to bring Delta into a specified range.

Modified ROCK entry: ◦ Enter the put butterflies and then add 10 OTM calls at

approximately 5-10 Delta to cut our entry Delta back to specified range.

M3 and Bearish Butterfly entries:◦ Performed per their respective guidelines

CAT◦ CAT entry will be covered in the M21 program

Entry Types

RUT Butterfly position size - $50,000 PC =10 contracts scaling up to as many as 30 contracts.

All profit, loss, Delta and Theta numbers within these guidelines are based off of a $50,000 PC position size.

If you are trading a different position size, you MUST ADJUST YOUR NUMBERS ACCORDINGLY.

Delta/Theta ratios are ratios and remain the same regardless of position size.

Position Size for Examples

Planned Capital “IS” a fixed number that we use to base our risk management numbers off of which is “a reasonable representation of the maximum amount of capital we are likely to have in the trade during an average month”.

Planned Capital “IS NOT” the maximum amount allowed in the trade.

This position WILL sometimes significantly exceed Planned Capital.

We need a planned number because…Trades with varying capital cannot be properly managed with profits and losses based off of a percentage of “whatever is in the trade” because these trades almost always have substantially more money in them when they lose than they do when they win.

Using planned capital, your profit targets and maximum loss numbers will be predetermined or “fixed” DOLLAR amounts.

Planned capital may never reached or it may be exceeded, either way our profit targets and loss numbers remain the same.

Planned Capital

Planned Capital - $50,000

Minimum Capital Recommended in Account – 200% PC - $100,000

Profit Target – 20% PC - $10,000

Max Loss - 20% PC - $10,000

Notes:

◦ All data in the course is based off of back test results during the period from 11/25/05 thru 12/30/12 while following the guidelines presented . All entries were made at 3:30 PM EDT.

◦ A great majority of adjustments and exits were made at 3:30 PM EDT however the daily range is considered in this trade and therefore there may be multiple adjustments made intraday particularly near expiration.

Risk Management and Profit Targets

Entry: For the examples we will enter 30 DTE or closer if there is a holiday or if the previous trade is still open. (no overlap of months)

Butterfly Positioning: Put butterflies with the short strikes 10 – 20 points below underlying (on RUT)

We will model the put butterflies and check the Delta on the T+0 line 20 points above the short strike.

◦ If Delta is greater than -200 (more negative than -200), we will use a normal entry.

◦ If the Delta is less than -200 (less negative than -200), we use a high IV entry (Modified ROCK or M3).

◦ If the numbers are “close” we will use the charts to decide.

Entry Guidelines

Model 10 put butterflies 10 -20 points below the money (830) and check Delta

Currently, we are showing -206 Delta at RUT 841 BUT…We want to know if our Delta at 20 points over our short strikes (at 850) is more

than -200.

If we were less than -200 at RUT841, then we would want to check to see what our Delta would be “IF” the price was at

RUT 850, 20 points over our short strikes (-281)

If we have determined that we will do a normal entry and have entered the put butterflies….

Add call butterflies with 50 point wings placing our short strikes 40 points over the short strikes of the existing put butterflies until our Delta at 20 points over the short strikes of the put butterflies is less than -200

Guidelines for Normal Entry

In this case, we find that adding 5 870 call butterflies will bring the existing Delta to -59.

Let’s check the Delta at RUT 850

If RUT was at 850, our Delta would be -180.6 which is acceptable

This would be considered “ROCK” configuration

In higher IV environments we tend to get very large price swings. Under these conditions, trying to keep our trade high Theta usually results in excessive trade adjustments as well as unneeded losses. Therefore, it usually makes sense to adapt our position to create a flat T+0 line and not worry about being “under the tent”.

The ROCK uses the Delta of our put butterflies at a price point of 20 points over its short strikes as a guideline of when the market is too volatile for a normal entry and adapts by using a modified entry.

The position is then traded in a modified configuration until such a time the Delta indicates we would likely be better off in normal configuration.

High IV Entry

Entry: For the examples we will enter 30 DTE or closer if there is a holiday or if the previous trade is still open. (no overlap of months)

Butterfly Positioning: Short strikes 10 – 20 points below underlying (on RUT)

Check the Delta on the T+0 line 20 points above the short strike.

◦ If Delta is greater than -200 (more negative than -200), we will use a normal entry.

◦ If the Delta is less than -200 (less negative than -200), we use a high IV entry.

◦ If the numbers are “close” use the M3 entry.

Entry GuidelinesEntry Test

Model 10- 650 put butterflies and check Delta

We want to know what our Delta is 20 points over our short strikes (at 670). Currently, we are showing -90 at RUT 663. Therefore we

need to check the analyze graph to see if Delta is greater than -200 at RUT 670

Excessively flat Delta indicates the market is too volatile for a normal entry and we should

use a high IV entry modification

Model entering the 10 put butterflies and then add10 OTM calls with sufficient Delta to cut our position significantly Delta under -50

Check to see if the calls we modeled are under 10 Delta

IF the calls are under 10 Delta, then proceed with Modified ROCK entry

IF the calls need to be more than 10 Delta to get our position Delta under -50, then perform an M3 entry using M3R guidelines for timing the trade conversion back into ROCK configuration.

IF you could go either way, check the chart to see if the market is experiencing excessive chop or it is trending.

◦ If market is excessively choppy use Modified ROCK entry. ◦ If market is trending, use the M3 entry

High IV Entry GuidelinesOnce we have determined we will do a High IV entry….

Advantages of OTM calls◦ If you get a fast aggressive up move, they can provide very good protection◦ If you get an aggressive down move, they do not hurt the position as much as an

ITM call or vertical does

Disadvantages of OTM calls◦ If the prices sits, time goes by, you get only a moderate move in either direction

or a substantial volatility drop then the calls WILL lose money and hurt the position. In fact, I would say you will lose money over 80% of the time on those calls

◦ Your T+0 line is fictitious and will most likely collapse substantially to the upside when a move does occur

The only reason we are using OTM calls here is because conditions dictate that we may get an extreme move, even so, it will usually cost us. Therefore, we want to get rid of those calls as soon as conditions allow and switch back over to ROCK or M3 configuration.

When we are expecting excessive volatility, we are using OTM calls to hedge the position

to the upside

High IV Entry Model butterfly position and then model buying

10 OTM calls that cut our Delta to under -50

High Volatility Modified ROCK Entry

An M3 entry should be considered when the Delta of the put butterflies is closer to -200 or when IV is high and price movement is trending rather than in a wide range of chop

M3 Entry

Entry Test

Delta is -161 suggesting a high IV entry is required

Modified ROCK or M3 Entry?

Looks like an M3 Entry

M3 Entry

M3 Analyze Graph

In this section we covered:

◦ The 6 configurations of the trade Normal Rock Modified Rock M3 M3R CAT Bearish Butterfly

◦ The 3 most common ROCK trade entries Normal Rock Modified Rock M3

◦ How to use Delta numbers as an aid to determine which entry to use

Summary

Adjustment Guidelines for various configurations

A Simple Sample Trade November 2012 Expiration

In Part 2……

John Locke www.lockeinyoursuccess.com john@lockeinyoursuccess.com Facebook: Locke in Your Success Twitter: locke4success 603-738-1795

Locke In Your Success, LLC