Optionetics Platinum provides traders with quick and easy tools to identify position risk. Risk Graph I and Risk Graph II displays a chart view of risk accompanied by a price chart, as well as a table with risk-reward and net Greek data to more fully quantify the potential for loss. These are the most apparent risk tools on the platform; however, traders can focus on managing risk earlier in the process with Platinum.

Find Trades

The various Find Trade tools allow traders to rank the resulting list of trades in a number of different ways. One ranker is Smallest Max Risk. By selecting this option in place of Maximum Profit versus Risk, the trader is starting the process with risk in mind.

It's not uncommon for lower risk trades to correspond with lower rewards and/or lower probability trades. Unfortunately that is the nature of the beast - there are simply trade-offs that must be made when deciding which trades to pursue. On the positive side, the sheer number of possible trades that are suitable for a given market generally allows you to find the right combination of potential risk for a given reward.

Trade Scenario

Prior to using Find Trades II, the trader must identify a price and volatility outlook for a given group of stocks.

Outlook

Price Outlook: Figure 1 provides a weekly chart for QQQQ, the exchange traded fund [ETF] that serves as a proxy for the Nasdaq-100 Index (NDX), the component stocks used for the Find Trades scan. The chart displays:

• A long-term downward trending resistance line,
• A MACD histogram, and
• Volume bars.

The most recent price rise in QQQQ has been accompanied by diverging momentum and diminishing volume. This favors the long-term resistance line holding in the shorter-term. However, any price retracement may find support from the 20-day, 50-day or 200-day exponential moving averages [EMAs], all of which are below price (not shown). With this in mind QQQQ has the potential to build both bullish momentum and volume, with a push above this significant resistance area allowing a 5-10% move before another significant resistance area is encountered.

Figure 1: Weekly Chart for QQQQ with MACD and Volume
click here for larger view

Volatility Outlook: Figure 2 provides a weekly chart of VXN, the Volatility Index for the Nasdaq-100 Index along with an overlay of QQQQ. There is also a 10-week exponential moving average [EMA] which has served as a "reversion to the mean" area under normal conditions for the index. Volatility is relatively low in the short-term and below this mean reversion line, favoring a short-term increase in the measure.

Figure 2: Weekly Chart for VXN with 10-Week EMA and QQQQ Overlay

Find Trade Settings

Figures 3 & 4 display the Find Trade II settings used for this scan. Assuming a low volatility environment and a more neutral view for price on the Nasdaq-100 Index, a scan for long straddle and strangle strategies was completed on optionable stocks in the index. Smallest Max Risk was selected for the Trade Sort Method and minimum of 30 days selected for expiration.

Figure 3a: Find Trade II Scan

Figure 3b: Find Trade II Scan

Figure 4 displays the Smallest Max Risk trades, sorted a second time by the Kelly Bet Fraction. So the list provides the lower cost strangles with a higher probability of being profitable. Surprisingly, these include a number of positions which are shorter-term with expirations in September.

Figure 4: Find Trades Scan Ranked by Smallest Max Risk and Kelly Bet Fraction

Ordinarily you will seek more time in a strangle since the position is long two options. However, in this case there is relatively high short-term statistical volatility [SV] accompanied by relatively low short-term implied volatility (see Figure 6). This resulted in a low risk trading opportunity that ranked relatively high using the Kelly Bet Fraction, a probability tool in Platinum. Figure 5 provides a Risk Graph II display of the position.

Figure 5: Risk Graph II for AKAM Sep 17-21 Strangle

When looking at the probability of profit (PoP) prospects for AKAM, the 20-day SV of 89 yields a PoP of 62.9% while the 100-dy SV of 62 yields a PoP of 49.0%.

Figure 6: Statistical and Implied Volatility for AKAM

It should be noted that the trader needs to check the stock news when there is a divergence between the two. In this instance a drop occurred when the company's earnings report was issued, but a week later it jumped back up when Barron's reported strong insider buying for the company. Since neither of these news events are expected to repeat between now and expiration, a conservative approach uses the longer-term, lower SV when calculating PoP and other probability calculations.

While you need to decide for yourself whether this trade is one that suits your style, it highlights the different opportunities that can arise when you change the various trade sorting methods. In this case a focus on risk still provided a trade with reasonable profitability prospects.

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Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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